Japan's Current Account Balance, Investors' Bond Activity, and US Treasuries

Japan reported a smaller than expected June current account surplus. Seasonally, June tends experience deterioration from May. In fact, only twice in the past ten years has the current account improved in June over May.

On the other hand, investors can look forward to improvement in July. Since 2003 without fail, Japan's current account position improved in July over June.

One of the factors behind the broader deterioration of Japan's trade balance has been the fact that it has relied almost exclusively on energy imports since shutting down its own nuclear plants in 2011. However, starting tomorrow Kyushu Electric will begin bringing online a reactor at its Sendai facility. By the end of next month, operations are expected to return to normal. Another nuclear plant, part of the same facility, and has received regulatory approval, is expected to re-start around the middle of October.

Over time, the return of Japan's nuclear energy capabilities will likely help Japan's trade balance, even if adding to the world's glut of oil. It is very controversial in Japan (one poll had 57% opposed) and is unlikely to help Abe or his cabinet support ratings which have fallen recently.

With Japan's current account figures, the Ministry of Finance also provides a country breakdown of Japanese investors' activity in foreign bond markets. Japanese investors moved away from the larger deeper bond markets. They bought more Swedish and Dutch bonds than any other countries in June. They bought JPY173 bln of Swedish bonds after purchasing JPY34 bln in May (and selling JPY24 bln in April). Japanese investors also bought JPY104 bln of Dutch bonds on top of the JPY168 bln bought in May. British gilts were third on the shopping list, as Japanese investors bought JPY82 bln. Of note, Japanese investors bought JPY17 bln of Chinese bonds.

In June, Japanese investors sold a record amount of French bonds (JPY1.182 trillion) and sold German bunds (JPY866 bln) for a fourth consecutive month. They sold Italy bonds (JPY220 bln) after buying them in April and May (JPY358 bln over the two-month period). Japanese investors were also sellers of Brazilian (JPY41 bln) and Mexican (JPY39 bln) bonds in June.

Japanese investors sold JPY954 bln of US Treasuries in June, according to Ministry of Finance figures. Some news accounts play up the size of these sales, which appear to be the largest in a couple years. Yet the proper context is the outsized purchases in May. Then the MOF data shows Japanese investors bought JPY2.476 trillion in May and sales of JPY296 bln in April. These figures do not jive with the US Treasury data. In May, the US Treasury data shows Japanese investors reduced their Treasury holdings by $1 bln and in April by $9 bln. The next TIC report will cover June and will be released after the market's close on August 17.

The Federal Reserve acts as a custodian for foreign central banks and institutions for their Treasury and Agency holdings. They report the figures weekly. Custody holdings of US Treasuries rose $41 bln as of July 1 from May 27. Indeed, despite the talk of central banks (from China to Saudi Arabia and Russia), the Fed's custody holdings rose to a record high in early July to $3.035 trillion.

Emerging market currencies sold off hard last month. Only two emerging market currencies gained against the dollar in July, the Hungarian forint (1.1%) and the Romanian Leu (0.1%). The Fed's custody holdings appear to be largely a function of foreign central bank intervention. As the emerging market currencies sold off, US custody holdings of Treasuries fell by $49 bln through July 29.

Last week's report covering the week ending August 5 showed a seemingly inexplicable jump of $29 bln in the Fed's custody holdings. Yet all the emerging market currencies but the Indian rupee (+0.25%) fell against the US dollar.

A report by the Bloomberg yesterday had an inflammatory headline: China Slashed US Debt Stake by $180 bln, Bond Shrug. The report picks an arbitrary period beginning in March 2014. The US Treasury data covering that period is clear. In March 2014, Treasury figures estimated China's Treasury holdings at $1.272 trillion. As of May 2015, China held $1.270 trillion.

Where does Bloomberg's $180 bln estimate come from? It assumes that nearly the entire fall of Belgium's holdings reflect covert sales by China. The US Treasury estimates that Belgium's Treasury holdings fell from $381.4 bln in March 2014 to $202.8 bln in May 2015. The justification is a claim that Belgium is "home to Chinese custodial accounts." This is hardly convincing evidence that all of Belgium's sales were for China.