If you’re a seasoned investor, you’ll recognize the gentle pull of U.S. bonds, despite the global tango of interest rates and monetary policies. And it looks like that allure is set to persist, according to the mavens at Goldman Sachs.
For context, let’s hop across the Pacific to Japan. Since 2016, the Japanese central bank has been running a yield curve control policy, essentially keeping a tight grip on their short- and medium-term interest rates. This move, while integral to Japan’s quantitative easing strategy, made their bond market a tad less enticing for investors as global interest rates soared. Fast forward to the present, and Japan, a heavyweight in the U.S. bond market, is slowly turning the dial back on this policy.
Now, this move had a few market watchers biting their nails. Could Japan’s transition drive foreign investors toward the Japanese bond market and away from the U.S. shores?
The numbers paint a vivid picture. As of August’s close, foreign entities held a whopping $4.1 trillion in U.S. corporate bonds, accounting for an estimated 42% of the entire U.S. bond market of investment-grade and high-yield varieties. For perspective, that number reached its zenith at $4.7 trillion around mid-2021.
And here’s the kicker: even amidst a robust U.S. dollar and the increasing costs of funding and hedging, foreign investors scooped up $130 billion of U.S. corporate bonds in just the first eight months of this year.
Peek at the yield disparities, and it all makes sense. The 10-year U.S. Treasury rate sits pretty at 4.68%, overshadowing Japan’s 0.92%. The gap widens further when you consider corporate bond yields – just below 6% for the U.S. against Japan’s sub-1%.
Goldman Sachs offers a succinct view, pointing to the vastness and the dynamism of U.S. credit markets. These factors, coupled with the paucity of domestic alternatives, will probably act as a buffer against drastic reductions in foreign net purchases.
To sum it up: Japan’s evolving monetary policy might not have enough oomph to divert foreign interest from U.S. bonds. It would take a perfect storm – a mighty strengthening of the Yen, a dramatic surge in the Japanese Government Bond (JGB) yield curve, and a shrinking yield gap with USD bonds – to generate sustained selling pressure in the U.S. market. As Goldman aptly puts it, the current market makes this bar “remarkably high”.