* Japanese investors flock to US bonds
* Currency-hedging on investments means no impact on yen
* Rising hedging costs prompt investors to seek alternatives
* New business among financial intermediaries for better hedging
By Hideyuki Sano
TOKYO, June 3 (Reuters) - When Japan’s central bank shocked markets with its negative interest rates policy in January, its main aim was to squeeze investors out of safehavens and into assets that would stoke economic growth, like stocks and property.
While Japan’s perennially conservative investors have indeed pursued better returns away from Japanese government bonds, their hunt for yield has taken their money out of the country and into the U.S. debt market, particularly Treasuries.
Japanese investment flows into U.S. bonds hit multiyear highs in March, a sign Japanese policy efforts to reflate the economy out of stagnation are struggling.
What’s more, the prospect of a weaker yen from such outflows, which might otherwise have supported exporters, remains elusive due to increased currency hedging on these investments.
“Negative rates have changed the world. Japanese banks tend to endure (low returns) until they can, but negative rates have pushed them beyond their limit,” said Shuji Ikebuchi, director at Citigroup Global Markets.
U.S. Treasury data that looks at bond transactions between U.S. and non-U.S. residents shows Japanese investors net bought $31.3 billion of U.S. bonds in March, the most since January 2012.
Their buying is one reason the 10-year U.S. bond yield stands at 1.85 percent, down from 2.25 percent at the start of 2016, despite markets pricing in another interest rate hike in June or July, analysts said.
The New York Federal Reserve estimates that the “term premium” - or premium investors ask for holding longer-dated bonds - on 10-year U.S. Treasuries swung into negative territory in May, its lowest since 1962, from around zero at the start of this year.
Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities, said this is a result of monetary policy in the euro zone and Japan.
As Japanese investors want stable yen returns on foreign holdings, they are hedging away most of the currency risks.
This means the outflows have no net effect on the yen’s value, which has in fact strengthened more than 10 percent from the low it hit just after the Bank of Japan announced its negative rates policy.
It also means increasing cross-border transaction costs, which erode returns.
The return on 10-year Treasuries, for example, is just 0.43 percent after hedging costs, way below their 1.83 percent yield.
These meagre returns are prompting some Japanese investors to look at higher-yielding U.S. debt.
U.S. Treasury data showed Japanese investors in March bought net $11.7 billion in bonds issued by U.S. government-sponsored agencies such as Fannie Mae. The net buying was the third biggest on record.
While a lack of infrastructure and expertise typically keeps smaller and regional Japanese banks from being as aggressive in buying foreign bonds as their larger and global counterparts, negative rates mean they too are now switching.
This new interest in U.S. bonds from historically domestically-focused institutions has spawned a new cluster of products and services aimed at helping firms hedge such offshore investments.
Citigroup’s Ikebuchi said the bank is now getting more inquiries into its algorithm-driven hedging strategy aimed at lowering hedging costs. Its programme advises whether hedging is needed on a daily basis or more infrequent period, thereby reducing unnecessary hedging.
Alliance Bernstein offers a fund that enables investors to skirt hedging costs, by investing in U.S. mortgage debt without having to procure dollars.
“There’s no doubt that Japanese financial institutions’ buying in U.S. bonds is accelerating,” said Hiroshi Yokotani, head of fixed income business at Alliance Bernstein.
“On the other hand, because of market volatility we saw in January, high-risk foreign bonds are not favoured. As a result, they are buying U.S. Treasuries and other investment-grade bonds.” (Reporting by Hideyuki Sano; Editing by Nachum Kaplan and Sam Holmes)