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Japan’s Yield Hunters Seek European Debt

A trader monitors the foreign exchange and stocks index in Tokyo.
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Increased expectations of a jump in Japanese investment in Europe's bond markets following the Bank of Japan's drastic action to ease monetary policy helped drive borrowing costs lower across the continent on Monday.

The BoJ's massive bond-buying plans unveiled last week are forecast to push domestic yields down and encourage Japanese investors to venture abroad for better returns, fueling expectations of further declines in European borrowing costs.

"The amount of money in the Japanese government bond market that could leave Japan is monumental," said Bob de Groot, a head trader at BNP Paribas. "We've just seen the tip of the iceberg so far."

Investors are on high alert for signs that domestic Japanese investors are shifting into overseas markets. Traders at Citigroup said the vast majority of yen selling continued to be driven by hedge funds trying to front-run the wall of cash from Japan that is expected to hit global markets in the coming weeks.

However, some traders and bankers said Japanese investment had already increased noticeably in recent days and weeks, as local investors prepared for aggressive BoJ action.

"We've see big Japanese flows into Europe recently, and particularly into French bonds," said Demetrio Salorio, global head of debt capital markets at Société Générale.

France's 10-year bond yield fell to 1.71 per cent on Monday, a new record low and down from more than 2 per cent just a week ago. Austria's benchmark borrowing costs also fell to an all-time low, while German, Dutch and Finnish bond yields were also close to their trough.

But the biggest impact was in Europe's debt ridden periphery as the yield on Italy's 10-year benchmark fell 11bp to 4.31 per cent, while Spain's fell 9bp to 4.71 per cent.

Japan's army of retail investors has largely preferred to take advantage of the weaker yen to repatriate overseas assets this year rather than putting more money to work abroad. Analysts are predicting that lower Japanese bond yields will spur them into action in the coming weeks.

"Now that Japan's long-term bond yields look set to remain low – and the yen weak – for the next few years, domestic savers may venture into foreign assets with renewed interest," analysts at Bank of America Merrill Lynch said in a note.

The euro hit its strongest level against the Japanese yen in more than three years on Monday as investors returned to the short yen trade. The single currency has risen more than 7 per cent against the yen since the Bank of Japan surprised global markets last Thursday with its radical policy action. On Monday, the euro was more than 1 per cent higher at Y128.83, its strongest level since January 2010.

Buying the euro and selling the yen has been one of the most popular trades in the global foreign exchange market this year as hedge funds bet that the Japanese currency will weaken while snapping up cheap peripheral bonds earlier this year. Many speculators reversed that trade shortly before the Bank of Japan's meeting on Thursday.

The yen also tumbled again on Monday, falling 1.6 per cent against the US dollar to trade at Y99.15, the lowest since April 2009.

An analysis of internal flows by Nomura, the investment bank, showed that selling the euro and buying the yen was a popular trade among hedge funds earlier last week amid caution over whether the BoJ's stimulus measures would go far enough.

Currency traders reported hectic trading on Monday as investors who were not positioned for the weaker yen scrambled to make fresh bets it would fall further.

"What the BoJ is doing is unprecedented – we've had every type of client getting involved," said Mr de Groot.

Analysts singled out France as a particular beneficiary of Japanese investment abroad. Although some are concerned by France's economic and fiscal weaknesses, the country remains one of the most highly rated governments in the world and its bond market is among the largest and most liquid – a key factor for many investors.

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Emerging market bonds are also expected to be a big winner from Japan's aggressive policy easing.

The average blended yield of JPMorgan's EMBI Global Diversified index of bonds sold by the developing world tumbled more than 10 basis points to 4.61 per cent on Friday, the biggest one day drop since October 2011.

"The higher growth and interest rates offered by emerging markets may attract a significant portion of these savings," BofA's analysts said. "Within Latin America, Brazil and Mexico ought to benefit due to the size of their domestic bond and currency markets."