Risk of "Major Capital Repatriation" from Japan Intensifies! Japanese Bond Yields Approach 30-Year High, Over $1 Trillion in U.S. Treasury Holdings Under Scrutiny

Japan’s long-standing ultra-low interest rate policy has forced domestic investors to look overseas for higher returns, making the country one of the most significant exporters of capital in the world. At present, Japanese investors hold nearly $5 trillion in overseas assets, and Japan remains the largest foreign holder of U.S. Treasuries, with about $1.1 trillion in holdings.

However, this longstanding investment logic is shifting. Last week, the yield on 10-year Japanese government bonds briefly touched 3%, the first time at this level since 1996. Inflationary pressures, government fiscal outlook, and market expectations that the Bank of Japan may accelerate rate hikes have jointly pushed Japanese bond yields steadily higher.

Meanwhile, the yen has already risen by around 4% since September, making it the best-performing currency among G10 countries. Whether Japan’s Government Pension Investment Fund (GPIF) will increase its allocation to domestic bonds has also become a market focus.

Kenichiro Ueno, Japan’s Health, Labour and Welfare Minister who supervises GPIF, stated on Tuesday that the fund is still considering whether it is necessary to review its current asset allocation.

Ales Koutny, Head of International Rates for Active Funds at Vanguard Asset Management, noted that if domestic yields continue to rise in Japan, the country may gradually keep more capital at home, and this would not only affect the yen and JGBs but could also impact U.S. Treasuries, European bonds, and the broader global funding environment.

The market is particularly focused on whether GPIF will become a potential catalyst for capital repatriation. If GPIF increases its allocation to domestic bonds and encourages other pension funds, insurance firms, and individual investors to follow suit, the scale of Japanese overseas capital flowing back could be considerable.

Deutsche Bank previously estimated that in a bullish scenario where pension funds, insurance companies, and individual investors broadly adjust their asset allocations, the potential amount of capital flowing back into Japanese domestic assets could reach as much as $440 billion in the coming years.

Ashwin Binwani, founder of private investment company Alpha Binwani Capital, believes the market continues to underestimate the possibility of a “large-scale capital repatriation” in Japan.

Significantly, Japanese funds do not need to dump existing U.S. Treasuries and other overseas assets on a large scale in order to have an impact on global markets. As long as Japanese investors allocate less new capital overseas going forward, it could weaken a crucial, long-standing source of support for global bond demand, placing upward pressure on long-term borrowing costs for the U.S. and other economies.

In terms of yield, Japanese government bonds have already become notably more competitive for domestic investors. With dollar hedging costs currently close to 3%, the yield on 10-year U.S. Treasuries, after factoring in currency hedging, is about 2% in yen terms, actually about one percentage point lower than the equivalent Japanese government bond yield for the same period.

In other words, for Japanese investors needing to hedge dollar exchange rates, 10-year Japanese bonds now offer higher real returns—markedly different from the environment over past decades, which saw a flood of Japanese funds into overseas bond markets.

However, at least based on current actual capital flows, the so-called “big repatriation” of Japanese capital has not yet truly materialized.

Shoki Omori, Chief Fixed Income Strategist for Japan at Deutsche Bank, noted that as of August, there has been little evidence of Japanese life insurers actively selling foreign bonds, banks have only mildly reduced holdings, and pension trust funds continue to increase their overseas assets.

The current strategy adopted by Japanese investors is more about reducing currency hedging rather than directly withdrawing overseas capital. Omori estimates that the proportion of currency-hedged new overseas bond investments from Japan has dropped from 62% in 2024 to about 40% this year. As existing hedge positions mature, more new overseas investments are being made without hedging.

This means the future attractiveness of overseas bonds to Japanese investors will increasingly depend on the trend of the yen.

If the yen continues to appreciate, the motivation for Japanese capital repatriation could be further strengthened. As more Japanese investors hold overseas bonds without currency hedging, yen appreciation will directly erode investment returns in yen terms, while also reducing the appeal of the traditional carry trade—borrowing cheap yen to invest in higher-yielding overseas assets.

After the yen breached the key 155-yen-per-dollar threshold, some analysts expect the yen’s rise could accelerate further. If the Bank of Japan continues to tighten monetary policy and the U.S.–Japan yield spread narrows further, the necessity for Japanese investors to allocate substantial capital to overseas markets may diminish.

Nevertheless, there is still considerable disagreement on Wall Street about whether capital repatriation is imminent. Stephen Spratt, a strategist at Société Générale, pointed out that while the risk of Japanese capital flowing back exists, it remains unclear which types of investors would be the first to withdraw funds from overseas on a large scale.

Some analysts argue that the main factor holding Japanese institutions back from increasing domestic bond allocations is no longer insufficient yield, but rather a lack of investor conviction that JGB yields have peaked.

Masayuki Nakajima, Senior Strategist at Mizuho Bank, stated that from both a historical and asset-liability management perspective, a 3% yield on 10-year Japanese bonds is quite attractive. However, with uncertainties still surrounding inflation, fiscal policy, and how much higher JGB yields could climb, large institutions remain unwilling to increase long-term bond holdings prematurely.

He noted that compared to the absolute level of yields, yield stability is more crucial. Once investors are convinced that Japanese bond yields have stabilized, the same 3% yield could attract far stronger buying interest than seen currently.

James Athey, fund manager at Marlborough Investment Management, believes the conditions needed for Japanese capital to return home are already largely in place. With domestic bond yields rising, the U.S.–Japan yield gap narrowing, increasing expectations for more Bank of Japan rate hikes, and the yen starting to appreciate, the economic incentive for Japanese investors to reallocate assets internally is steadily increasing.

Athey said, given the current attractiveness of Japanese domestic bonds versus overseas bonds, he is surprised that more Japanese institutions have not yet shifted their bond investments back home.