Japan has moved from the largest portfolio investor in 2019 to a large disinvestment in 2022

Financial markets’ increased volatility in 2022, as global central banks turned hawkish to contain inflation, has had a toll on Japanese portfolio investment overseas. As the BoJ stubbornly continued to defend its yield curve control (YCC), the Yen significantly depreciated to USDJPY=150 on the back of an increasingly negative interest rate differential between Japanese and US sovereign bonds.

Japanese investors responded to the market volatility by reducing their expose to foreign portfolio, which is quite different from other large external creditors, especially China but also Norway. Germany also reduced its portfolio investment, but it did not disinvest massively like Japan. This has important implications for global financial markets, because Japan used to be the largest net creditor and has become the only net seller among the top five net creditors (Chart 1).

With surging inflation and hawkish central banks, Japanese investors’ allocation to fixed income portfolio was sharply cut across regions (Chart 2). The largest reduction was for US bonds, because the hedging cost against the USD skyrocketed as monetary policies between the hawkish Fed and the dovish BoJ polarized. Furthermore, Japanese investors trimmed their bond exposure in Europe, as the region suffered from accelerating inflation triggered by the disruption in Russian gas supply.

Nevertheless, their risk appetite didn’t evaporate. Japanese investors’ exposure to US equities increased, as some investors arguably attempted to bottom fish the market as global commodity prices began to stabilize from the second half of last year.

Evolving financial regulation for Japanese banks and lifers could have played an important role in the risk aversion in 2022. As global interest rates and hedging costs rose sharply, unrealized losses expanded in 2022, which arguably prompted banks and lifers to reduce their exposure on international assets to prepare for the coming tighter regulations. For example, Japanese banks will be required to fully comply with Basel III by the end of March 2025, while the FSA will apply to lifers new capital regulations with a similar framework to the EU’s Solvency II from 2025. In fact, their appetite to international portfolio hasn’t recovered after global bond yields and the Yen stabilized at the end of 2022, which means that mor structural factors may be at play.

While Japanese investors significantly reduced their exposure to foreign assets at an aggregate level in 2022, future strategies will very much depend on the BoJ. As some point, the BoJ will need to adjust its monetary policy by lifting the ceiling on the 10-year JGB. Meanwhile, the search for yield will continue.

Full report is available for Natixis clients.