Japanese pension funds may hold key to Chinese JGB puzzle

China stormed back into Japanese government bonds over the summer with ¥2.2tn ($21bn) in purchases between June and August — the biggest three-month spree since Japan’s Ministry of Finance began compiling data in 2005.

The country has made several similar incursions to the JGB market since 2016 — the previous record high for purchases — snapping up Japan’s notoriously low-yielding debt on a grand scale and causing head-scratching over what might have triggered the rush.

One interpretation is that China’s JGB purchases over the four years of the President Donald Trump’s administration are a proxy for geopolitical tensions. On this reading, China has diversified some of its vast foreign-currency reserves out of US Treasuries as a direct response to rising trade and diplomatic strain between Beijing and Washington. The symbolism of JGB purchases is all the stronger because of the historic animosities between Beijing and Tokyo. 

Several top JGB analysts, using cautious language, see this as plausible: the currencies team at JPMorgan noted last week that it was “not difficult to imagine” that some Chinese JGB purchases were driven by geopolitics. Bond analysts at Bank of America suggested the purchases would be likely to continue “if US-China tensions also continue”.

But this is at odds with growing signs of how closely the two financial systems are linked, from China last week issuing debt directly to US buyers for the first time, to the US welcoming a rush of Chinese stock market listings.

Analysts at Nomura offer an alternative explanation: Japan’s growing appetite for overseas bonds offering yields that are not available at home. In many cases, that involves Japanese investors buying dollars from major holders such as those in China, leaving those Chinese accounts with yen that tends to be invested for the short term in JGBs.

Pension funds have driven these Japanese outflows in recent months, with the Government Pension Investment Fund leading the charge. In the week that ended on October 10, Japanese investors bought about ¥1.9tn worth of foreign bonds, according to Nomura — about five times the average weekly pace in 2019.

China’s surging JGB purchases are therefore either technical or political. The question will be resolved depending on which happens first: China-US tensions subside, or Japanese investors cut back on foreign bonds.