Selling U.S. bonds, buying Japanese bonds, Wall Street prepares for "Japanese capital inflow"

The Japanese government bond market is experiencing unprecedented volatility in decades, prompting global asset management firms to reevaluate a long-overlooked risk: will Japanese investors, holding about $1 trillion in U.S. Treasuries, move their money back home?

According to the latest report from the Financial Times in the UK, several investment institutions have begun preparing for a large-scale repatriation of Japanese funds, betting that Japanese investors will gradually sell off U.S. Treasuries and instead buy Japanese government bonds (JGBs), which are experiencing rising yields.

Japanese bond yields soar to multi-decade highs

On Friday, the yield on Japan’s 10-year benchmark government bond rose intraday to 2.73%, the highest level since May 1997.

The 30-year JGB yield broke through 4% for the first time—an unprecedented level for this maturity since its initial issuance in 1999. The yields on 5-year and 20-year government bonds also hit record highs earlier this week.

Japanese Finance Minister Satsuki Katayama told reporters on Friday that yields in major global bond markets are rising “and these dynamics are interacting, creating a compounded effect.”

Analysts expect Japanese bond yields to continue climbing. The Bank of Japan raised its policy rate to 0.75% in December last year, the highest in three decades, and markets widely anticipate a further 25 basis point hike to 1% in June.

The trillion-dollar “return home” logic

To understand this betting trend, it’s essential to grasp why Japanese investors hold such large overseas assets.

Over the past decades, Japan maintained ultra-low interest rates, providing little return on domestic bonds. To pursue higher yields, Japanese insurance companies, pension funds, and banks have heavily invested abroad, buying U.S. Treasuries, European bonds, and various global assets.

Currently, Japanese investors hold about $1 trillion in U.S. Treasuries, making them the largest foreign holders of U.S. debt, far surpassing other countries.

Now, with Japanese bond yields rising sharply, this logic is reversing. Mark Dowding, Chief Investment Officer at UK asset manager BlueBay, explicitly pointed out this shift. BlueBay launched its first Japanese bond fund just this March.

Dowding said, “New funds will no longer be allocated abroad. They won’t flow into U.S. corporate bonds or U.S. Treasuries but will return to domestic Japanese assets.”

Funds have already begun to “trickle back”

Market data shows signs of fund reflows, although on a small scale.

According to data from fund tracking firm EPFR, in March, investors net flowed approximately $700 million into Japanese sovereign bond funds, the largest monthly inflow on record for this category. In April, net inflows were $86 million, returning to recent normal levels.

Ruffer fund manager Matt Smith expressed a more direct view. He said, “Pressure is building—the long-term domestic yields are rising steadily, and the signals from institutions are ‘bring your money back to Japan.’ We believe the yen will appreciate slowly at first, then accelerate suddenly.”

Smith also noted that Ruffer is currently holding a long position in yen as a core hedge. “Once market turbulence occurs—especially around the U.S. credit market—Japanese investors will bring capital home, and the yen will strengthen.”

Repatriation has not yet become widespread, and Japanese bonds themselves carry some risks

However, analysts warn that Japanese institutional investors are still net buyers of foreign bonds.

Abbas Keshvani, macro strategist at RBC Capital Markets Asia, pointed out that although Japanese bond yields have “on the surface provided better compensation,” over the past 12 months, Japanese investors still net bought about $50 billion in foreign bonds.

The reason lies in the uncertainty surrounding the Japanese bond market itself. Japanese Prime Minister Fumio Kishida won the February elections with promises to expand government spending and subsidize inflation pressures. Increasingly, analysts warn that the government will be forced to prepare supplementary budgets later this year, which could further depress Japanese bond prices and push yields higher.

Keshvani said, “Supply and demand dynamics point toward yields continuing to rise. As an investor, if you know yields will keep climbing, it’s hard to want to buy now.”

Previously, the Bank of Japan was the market’s most significant buyer, purchasing large quantities of JGBs through quantitative easing and yield curve control policies. As the BOJ gradually exits these policies, the market is reverting to traditional supply and demand logic, leading to more pronounced bond price volatility.

What does this mean for the U.S. bond market?

The potential scale of Japanese fund reflows compels the U.S. bond market to take this risk seriously.

Japan is the largest foreign holder of U.S. Treasuries, with holdings around $1 trillion. If Japanese institutional investors begin systematically reducing their holdings, the impact on U.S. bond supply and demand could be substantial.

Currently, Wall Street’s bets are more about strategic positioning rather than reacting to actual events. But as Japanese bond yields continue to climb—analysts see a realistic target of 3% for the 10-year JGB later this year—this betting logic will become increasingly clear.