Analysis: High-yield and U.S. debt at risk if Japan repatriates

LONDON Thu Mar 17, 2011 1:22am EDT

LONDON (Reuters) - High-yield bonds and U.S. Treasuries top the list of vulnerable assets should the triple disaster of earthquake, tsunami and nuclear breakdown prompt Japanese investors to bring overseas funds back home. Such moves -- which may already be under way, given some of the currency movements of the past few days -- are also likely to sour global merger and acquisition and outward direct investment activity from Japan, one of the top 10 players.

The stakes are significant for world financial markets if Japanese investors bring money home to fund reconstruction, which is expected to cost around $180 billion, or around 3 percent of its gross domestic product.

"One of the issues when the immediate problem dies down is bringing the funds back home," said Ian Bright, senior economist at ING. "Japanese investment is widespread all over the world."

Japan holds nearly $7 trillion of external assets. Excluding the more than $1 trillion of this that is in foreign reserves, around $2.6 trillion is held in foreign bonds and money markets and another $680 billion in overseas equities.

U.S. Treasuries are, of course, a major pull, with Japan as a whole investing around $890 billion in them.

The Bank for International Settlements also estimates that Japanese banks hold around $745 billion in cash and fixed income in non-emerging Europe.

One of the first areas which may come under pressure, beyond the well-known U.S. Treasury holdings, is high-yielding foreign currency bonds, known as Uridashi, which are very popular among Japanese households, particularly in South Africa and Brazil.

Japanese investment in Brazilian debt rose by 84 percent in 2009, the most recent year for which data is available, to around $17 billion, according to the Bank of Japan.

Thomson Reuters data shows Japan-based funds hold $197 billion in foreign bonds, with the United States, Australia and Brazil comprising the largest source of issuance.

HSBC's data show the total issuance of Uridashi bonds totaled $4.6 billion so far this year, 43 percent of which was issued in Australian dollars. Of $14.1 billion of Uridashis issued last year, Aussie bonds totaled $6.6 billion and Brazilian real bonds in $2.4 billion.

"From a repatriation flow perspective, the flow could be most dramatic for the Australian dollar and Brazilian real," HSBC said in a note to clients.

BRINGING IT HOME?

The yen is the primary signal that some repatriation, or at least an expectation of it, is already underway.

Since Thursday, just before the quake, the yen has risen 3 percent against the Brazilian real and more than 4 percent versus the Australian and New Zealand dollars.

The biggest loser was the South African rand, which lost more than 5 percent.

After the Kobe earthquake in 1995, the yen rose more than 20 percent to a then post-war high around 79.80 per dollar in a space of around three months, although appreciation was also driven by speculation about Federal Reserve policy easing.

Some of what is under threat is seen in the latest Reuters poll of 13 Japanese fund managers conducted in February.

It showed investors holding 59 percent of their equity assets in North America and Europe and the same in their bond portfolios.

Finance Ministry data for 2010 showed Japanese investors bought a net 25.8 trillion yen ($316 billion) of foreign stocks, bonds and money instruments, with 69 percent allocated in the United States. Australia grabbed 6 percent of the pie.

In January, the Japanese government bought just over 1 billion euros of bonds issued by the European Financial Stability Facility.

CORPORATE FINANCE ACTIVITY

Japan's influence on world finances is not, of course, limited to asset holdings. It is also a big driver in foreign direct investment and well as overseas mergers and acquisitions -- some of which may be scaled back in the medium term.

The Organization for Economic Co-operation and Development estimates that Japan has been among the top 10 sources of international M&A over the past five years.

It accounted for $28 billion of the global $680 billion in 2010 and around $32 billion of $580 billion in 2009. UNCTAD, the U.N. trade and development agency, meanwhile, says that outward Japanese foreign direct investment -- including M&A -- amounted to $74.7 billion in 2009.

It is by no means certain, however, that Japanese investors will liquidate their overseas assets first if they needed cash.

They own plenty of Japanese government bonds -- 95 percent held domestically -- and it's easy to find sellers: The BOJ has just pledged to buy 10 trillion yen of bonds, mainly JGBs.

"You have to figure that that will be the first place they would go," said Jeremy Armitage, global head of research at State Street Global Markets.

(Additional reporting by Carolyn Cohn, Sebastian Tong and Caroline Copley; Editing by Hugh Lawson)

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