Five Japanese life insurers say they may buy more unhedged foreign bonds, believing that the yen is likely to weaken and that the currency risks are low enough for them not to take on higher hedging costs, a stance that points to some potential support for the dollar.
Many in the market had believed that Japan’s insurers may repatriate funds in the wake of last month’s earthquake, tsunami and nuclear crisis, but their plans to buy foreign bonds, both unhedged and hedged, run counter to those expectations.
The top nine insurers, whose combined assets under management of $1.9 trillion are worth more than the gross domestic product of Brazil, said the disasters had not had a major effect on their investment plans.
They expect Japan’s economy to be hit hard but also expect it will pick up later in the year helped by a moderate recovery in the global economy.
Traditionally Japanese insurers have preferred to hedge currency risks in foreign bonds, with about 80 percent of their foreign bond holdings hedged on average as of last September.
Those now looking to reduce currency hedging are top life insurer Nippon Life Insurance as well as Meiji Yasuda Life, Asahi Life, Fukoku Mutual Life Insurance and Daido Life Insurance.
They think the time is ripe to sell the yen, believing it unlikely to go beyond the record high of 76.25 yen to the dollar hit just days after the March 11 earthquake, leading to rare joint intervention by the Group of Seven (G7) countries to send it lower again.
And in contrast to other countries which are embarking on monetary tightening, the Bank of Japan is also expected to stick to its ultra-easy policy as the nation grapples with the task of rebuilding, which should keep the yen under pressure.
Planned net increases in their unhedged foreign bond investments are expected to come to a few billion dollars in a currency market where $4 trillion change hands a day — not enough to be a big force pulling the greenback higher.
“While they are looking to sell the yen, their plans seem to be conditional and they may buy only when the dollar falls. So the upshot is that their buying could help stem a fall in the dollar but it won’t boost the dollar,” said Masafumi Yamamoto, chief FX strategist at Barclays Capital.
But Koji Fukaya, chief FX strategist at Credit Suisse, said that if other types of Japanese investors, such as pension funds, followed a similar strategy, it could give the greenback a lift.
“They are looking at the upside risk in the dollar. That’s becoming clear,” he said.
Fukoku Life, for example, is planning to raise its foreign bond holdings by 70 billion yen ($826 million) in the year that started this month, after an increase of 250 billion yen last year.
“The environment doesn’t look bad for allocating fresh funds to foreign debt, with the yen expected to be weak and overseas interest rates likely to rise,” said Takehiko Watabe, general manager of financial and investment planning at Fukoku.
Nippon Life, the country’s biggest insurer with assets of 49 trillion yen, also said it is considering unhedged foreign bonds, albeit without a specific target in mind.
“We expect the yen to be trapped in a range but there will be ups and downs, and we expect there could be times when we buy foreign bonds,” said Yosuke Matsunaga, general manager of Nippon Life’s finance and investment planning department.
“We would like to increase our holdings of unhedged foreign bonds if we can buy them at attractive exchange rates,” he said.
Nippon Life expects the U.S. currency to be somewhere between 75 yen and 95 yen at the end of the current financial year, compared with 83.15 yen in March.
The rising cost of hedging is also encouraging Japanese investors to reduce hedging. To hedge against a fall in the dollar, insurers normally sell the dollar at a future date in a forward transaction. Forward rates are determined by interest rate gaps, and the higher U.S. rates are compared to Japanese rates, the more insurers have to pay.
The spread in six-month LIBOR rates has been stuck around 0.1 percent in the past several months but it is seen widening as the Federal Reserve moves closer towards tightening.
The cost for hedging against a decline in the euro has already soared as money markets have priced in rate hikes by the European Central Bank.
Nevertheless, some other insurers said they do not plan to reduce hedging as hedged foreign bonds remain an attractive alternative to low-yielding yen bonds.
Ten-year U.S. bonds currently yield 3.35 percent compared to 1.2 percent for Japanese government bonds of the same maturity, giving Japanese investors decent returns even after the cost of hedging is deducted.
RISK REDUCTION
All of Japan’s top nine life insurers said they remain eager to cut risk, and they plan to increase their yen bond holdings this financial year by a combined 3 trillion yen ($36.7 billion).
Seven of them plan to continue their retreat from domestic shares ahead of new regulations that raise risk weightings for stocks and other riskier assets.
In addition to the new government regulations this financial year, insurers are concerned about the prospect of fair-value accounting for their liabilities to policy holders being introduced in the future.
As the average duration of their yen bond portfolios is shorter than their liabilities, they are keen to buy more yen bonds to reduce the mismatch and cut their exposure to yield fluctuations.
That appetite for debt has helped keep yields low despite Japan’s deteriorating fiscal position.
Some life insurers said government bond yields could rise later in the year when Japan’s heavily indebted government is expected to sell more bonds to finance reconstruction work and as the economy picks up.
Even before the earthquake, Japan was saddled with a public debt twice the size of its $5 trillion economy.
The nine insurers’ forecasts for 10-year Japanese government bond yield this financial year ranged between 0.8 percent and 1.8 percent.
($1 = 81.845 Japanese Yen) (Editing by Edwina Gibbs)
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