On September 3rd, the yield on 30-year US Treasury bonds was 5.25%, while the yield on 30-year Japanese government bonds was approximately 4.05%, and the average yield on new bond auctions during the same period was 4.079%. On the surface, US Treasury bonds, with their approximately 120 basis points higher yield, seem more attractive.
However, for Japanese life insurance companies whose liabilities are denominated in yen, the real comparison is the return after currency hedging. The yield on 1-year US Treasury bonds was approximately 4.11%, while the yield on 1-year Japanese government bonds was approximately 1.56%. Roughly estimating based on the short-term interest rate differential between the two countries, hedging against dollar exposure would require an annual cost of approximately 255 basis points. This translates to a return of approximately 2.70% after hedging with US Treasury bonds, which is actually about 135 basis points lower than directly holding 30-year Japanese government bonds. This case illustrates that the decision to purchase US Treasury bonds by Japanese funds is not solely based on the yield differential between long-term US and Japanese bonds, but also includes short-term interest rate differentials and foreign exchange hedging costs. As Japanese long-term bond yields rise, domestic bonds can now better match yen liabilities, naturally reducing the incentive for Japanese life insurance companies and pension funds to continue increasing their US Treasury bond hedging. Reuters data shows that as of August 22, Japanese investors had net sold about 3 trillion yen of overseas bonds this year, with rising domestic yields and high hedging costs driving some funds back to Japan.
