Japanese Capital Flows: Six Observations

The following observations are drawn from the weekly report of Japan's Ministry of Finance unless noted otherwise. We use the weekly data instead of monthly to identify changes of trend earlier. We use simple convention of the week by the last rather than the first day. That means that the report for the week ending April 1 is the first week of April. To smooth out the volatility, we will often refer to a four-week average. The latest MOF report was released earlier today.

1. Japanese investors bought a record amount of foreign bonds in the four-week period last month (JPY1.47 trillion or roughly $13.0 bln). It was nearly twice the amount in February and a little more than twice the purchases from March 2015.

Except for the second week in February, which is when market volatility peaked, Japanese investors were consistent buyers of foreign bonds since the start of the year. They were larger sellers of foreign bonds in the first half of April, possibly contributing to the yen's strength. In the first two weeks of April (technically weeks ending April 1 and April 8), Japanese investors sold JPY2.7 trillion of foreign bonds. Data out today showed Japan returned to the buy side in the most recent week, purchasing JPY845 bln.

2. Foreign investors bought large amounts of Japanese stocks in the early days of the Abe government. However, more recently, they have been sellers. The four-week average has been negative (net selling) since last September. Foreign investors were net sellers of Japanese shares since the second week of the year through the end of March. However, over the last three weeks, buyers have reemerged, snagging JPY1.1 trillion over the period. The buying has been sufficient to lift the four-week average into positive (net buying) for the first time this year.

3. Japanese pension funds have been engaged in a large-scale diversification effort, partly driven by low yields in the JGB market. As the BOJ has bought bonds, government, and private pension funds, have been buying foreign stocks and bonds, and domestic equities. Bond flows dwarf the equity flows. The four-week moving average of Japanese purchases of foreign equities set a record last August of around JPY560 bln. They have turned net sellers more recently. The recent data indicates the net selling was extended for a fourth consecutive week, and at a quickening pace. Last week's sales of JPY503 bln was among the largest since at least 2000.

4. Counter-intuitively, foreigners are notable buyers of Japanese government bonds and apparently have not been deterred by the negative yields. In the first three weeks of the year, foreigners sold about JPY500 bln of Japanese bonds, but since then, they have been mostly buyers, with the four-week moving average positive until the last two weeks of March. In those last two weeks of March, foreign investors sold JPY2.4 trillion of Japanese bonds. This month, foreign investors have come back and bought about JPY1.7 trillion over the past three weeks.

5. Owing to the relative volatility, institutional investors typically hedged (or carry higher hedge ratios) on foreign bonds than foreign stocks. However, foreign investors had been hedging the yen when purchasing Japanese shares. Japanese investors have reportedly been raising their hedge ratios on their foreign bond purchases. While the MOF makes weekly portfolio flow data available, and the CFTC makes futures positioning easily accessible, the hedging ratios, and strategies are not in public realm. We track the positioning of speculators in the futures market not because the size is significant compared with other flows. Rather we find the speculative positioning generates insight into another market segment (trend followers and momentum traders). It may be a proxy for parts of the larger leveraged community, such as hedge funds.

Occasionally news wires will conduct or report on surveys of some institutional investors, such as the insurers, with some insight into hedging. Often time analysts at Japanese banks include such insight in their reports. Arguably too often equity analysts and reporters do not press for more information on hedging strategies from the companies they cover.

6. Another set of flows that are many observers do not think consider, and one must admittedly get one's hands dirty in the data, earnings on Japanese investors large holdings of foreign bonds and stocks, as well as the earnings from its direct investment, is significant. In fact, such income from Japan's foreign holdings drives Japanese current account balance, not the trade in goods and services. The 12-month average of Japan's investment income, which includes dividends, coupons, royalties, licensing fees, was a record JPY1.7 trillion. We need a few more months of data to confirm anecdotal reports that the yen's strength in recent weeks had been at least partly fueled by the repatriation of dividends or corporate earnings.

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