More Thoughts about Japan and US Treasuries

new japanThe US Treasury International Capital report for the month of November 2017 was released yesterday.  It showed that the two largest foreign holders of US Treasuries, China and Japan, were net sellers.  China sold about $12.6 bln and Japan sold about $9 bln of US Treasuries.  Foreign investors sold $6.4 bln of Treasuries, meaning that outside of China and Japan, other foreign investors were net small buyers of Treasuries.  

The offshore centers, where some hedge funds may be located for tax purposes, of Bermuda and Cayman Islands were net unchanged on the month.  We know from more recent Commitment of Traders data that large speculators turned net short 10-year Treasury futures in the middle of December for the first time in eight months.  The large speculators have been short two-year Treasury futures since last May.

Sometimes the monthly data print obscures the larger picture.  Consider that last year through November, the TIC data shows foreign investors bought $390 bln of US Treasuries.  The US runs a current account deficit and therefore must import capital.  In the first nine months of 2017, the US current account deficit was about $338 bln.

China’s reserves fell in 2015 and 2016 by nearly $1 trillion, and over this period its Treasury holdings fell by almost $200 bln. In 2017, with the help of capital controls and a change the yuan’s direction, China accumulated reserves.  China’s reserves rose by nearly $130 bln in 2017, while through November, the US estimates that its Treasury holdings increased by $118 bln.

If China wants to accumulate reserves, it will have to buy US Treasuries, even if not every month.  There simply is no other market as liquid and deep as the US Treasury market.   Of course, it could shift its allocation toward the euro but it gets significantly lower yields and less liquidity.     In contrast, Japan is not accumulating reserves like China.  Valuation shifts account for the $47.3 bln increase in its reserves in 2017.  Japan’s Treasury holdings fell by $6.7 bln in the first 11 months of 2017.

Some observers have been playing up the increased cost to hedge Treasuries as a reason Japanese investors sold Treasuries.  The TIC data shows that Japanese investors were net sellers of Treasuries from August through November to the tune of about $30 bln, which is a minuscule fraction of its holdings.  Consider that of its $1.261 trillion of reserves in November, the TIC data shows Japan (not just the BOJ, but probably mostly the BOJ) held $1.084 trillion of US Treasuries then.

On one hand, Japanese institutional investors are thought to be attract by the high yields available in the US Treasury market.  On the other hand, the wider differentials at short-end make hedging the currency risk more expensive.   This may help explain why Japanese institutional investors have preferred European bonds, according to the recent MOF data.  Japanese investors have preferred UK, Swedish, and French bonds.

At the same time, there seems to be other forces at work besides relative yield curve developments.  According to the TIC data, Japan’s holdings of US Treasuries peaked in November 2014 near $1.241 trillion.   They have fallen by a little more than $157 bln over the past three years.  Japan’s Treasury holdings are at four-year lows.

There also appears to be a large seasonal factor that few observers have recognized.  Specifically, over the past decade, Japan often accumulates Treasuries in the first part of the calendar year.  It has been biased in the past several years to be sellers late in the year. From 2007 through 2016, Japanese investors sold Treasuries in December in seven of the 10 years.   Beginning in 2015 and running through 2017, Japanese investors consistently sold US Treasuries from August through December without fail.  In the middle of next month, the TIC data for December 2017 will confirm our suspicions that Japanese investors sold Treasuries last month.