Thursday, October 11, 2007

Japanese Investors Join Flight to Quality

Japanese investors' move into foreign bonds last month was unusual for September and likely was driven by the flight to quality sparked by the subprime-loan crisis and expectations that the U.S. economy would slide into recession.

Japanese bought a net Y3.3 trillion of foreign bonds last month, their first net purchase since May. It marked the largest net purchase of foreign bonds by Japanese investors since October 2005, according to Ministry of Finance data.

Japanese also were net buyers of foreign stocks in September, but on a much smaller scale, taking a net Y74.1 billion.

Such moves are unusual for September, when books for the first half of Japan's fiscal year are closing and investors tend to stand on the sidelines. It likely reflected the fallout from the subprime-mortgage crisis this summer, which sparked a flight to quality in markets around the world, with sovereign bonds seen as a much safer investment than stocks.

"The swing is quite large and I think it reflects the flight to quality that we saw around the world, including among Japanese running their foreign bond portfolios," said John Richards, a strategist for Royal Bank of Scotland in Tokyo. "They tried to jump on the bandwagon."

If so, their timing wasn't great: The Federal Reserve's 50-basis-point cut in the federal funds rate in mid-September stabilized the U.S. market and helped bolster share prices, sending bond prices tumbling. In addition, recent data has shown unexpected resilience in the U.S. economy, damping the chance of a recession that would take the air out of the stock market.

"I think they were probably somewhat disappointed by the subsequent data and the markets' reaction," Richards said.

At the same time, foreign investors were selling their Japanese holdings, selling a net Y647.8 billion of Japanese bonds and a net Y580.3 billion of Japanese stocks.

"Foreigners probably got the Fed game right and recognized that the flight to quality was over," Richards said.

But foreigners did buy short-term bonds, he said, a move to take some profits and park their money in the short end of the market, where it is less exposed to duration risk.

"They probably escaped a good part of the sell-off that we saw in Japan," as JGB prices also fell and the Nikkei rose after the Fed easing.

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