When investing overseas, Japanese institutions can either leave currency exposure unhedged or hedge it back into yen. For life insurers, pension funds, and banks, hedging is usually required because they report in yen and regulators prefer fewer FX risk surprises.
In theory, an investor could buy a 20-year U.S. Treasury and hedge it for 20 years. In practice, most hedges are five years or shorter because long-dated cross-currency swaps are less liquid, lack natural counterparties, and thus come with a higher liquidity premium.
Over the past year, hedge costs have declined substantially. Using the 3-year cross currency swap (CCS) as a reference, implied hedging costs have fallen from about 3.5% in 2025 to 2.3% today. At the same time, the yield differential between U.S. Treasuries and Japanese Government Bonds has narrowed from around 3.5% in 2025 to about 1.9% currently. Hedging costs have declined by 1.2%, while bond yield differentials have narrowed even more by 1.6%.
One of the key drivers is shifting dynamics in Japan's economy, including a more expansionary fiscal stance and the loosening of yield curve control (YCC). JGBs and U.S. Treasuries are deeply interconnected, and Japanese investors are the largest foreign holders of U.S. Treasuries globally at USD 1.2 trillion. Rising JGB yields have reduced the relative attractiveness of U.S. Treasuries, and Japanese institutions have begun reallocating capital back home.
Recent Ministry of Finance data show Japanese investors net sold ¥4.1 trillion (~USD 26 billion) of foreign debt securities in March, with over 90% in long-term bonds. Year to date, net sales of foreign long-term debt total roughly ¥6.5 trillion (~USD 41 billion).
My Treasury view remains unchanged. The two main risks are persistent: inflation disruptions from geopolitical risks and a broader carry trade unwind. And as they say, when the elephant moves, it shakes the entire market. Together, I see no fundamental reason for yields to move lower. The bias, all else equal, is higher.
Source: Japan Ministry of Finance (MOF), George Smith Partners
