Japanese investors put faith in JGBs Six months ago the Bank of Japan in effect issued an ultimatum to domestic investors: get out of the Japanese government bond market, or suffer the consequences. As the BoJ looked to push down interest rates by buying huge quantities of JGBs, institutions and individuals were expected to stand aside, swapping bonds for riskier assets such as stocks, loans and property. It would be even better - BoJ insiders added privately - if investors also put money to work overseas. Flows of funds across the border would have the happy side effect of putting downward pressure on the yen, helping the country's all-out push to end deflation. So are the Japanese coming? Not really. While there are signs of a pick-up in foreign bond purchases in recent months, the big institutions - banks, insurance companies and pension funds - are mostly still sitting on their hands. And the household sector is doing as it always has done, pouncing on voguish currencies such as the Mexican peso and the Brazilian real, but without a wholesale shift from the bank deposits that are recycled into bonds. Net foreign-currency denominated assets in mutual funds stood at less than Y25tn ($256tn) in August, according to the Investment Trusts Association, down from Y26tn at the turn of the year. So far, there has been "little evidence of the "portfolio rebalancing" that the BoJ's [easing] is meant to encourage," says Shin Kadota, foreign exchange strategist at Barclays in Tokyo. Since the beginning of July net foreign bond purchases by Japanese investors have amounted to Y5.2tn, data showed last week, following Y10.6tn of net sales over the first six months. But for any sort of sustained movement of cash overseas, say analysts, the key condition is that US interest rates settle into a stably rising trend. For now, the yield spreads - about 200 basis points between 10-year JGBs and US Treasuries - are attractive but some way off the 250bp-350bp zone that lured trillions of yen of outflows between 2003 and 2007. The fall in US yields since September has dragged down other developed markets, curbing outbound flows for now, says Yujiro Goto, forex strategist at Nomura. "I don't think banks will accelerate foreign-bond investment soon," he says. Meanwhile, domestic assets remain a powerful draw. For banks, for example, weak demand for loans is pushing down the interest rate on new lending, making less-risky JGBs an appealing alternative. Even "megabanks," which spent the first few months of "quantitative and qualitative easing" dumping JGBs, added almost Y60bn to their holdings in August, in the first gain since new BoJ governor Haruhiko Kuroda came on the scene. Lifers will continue to look to JGBs to match the duration of liabilities, and foreign bonds to match the coupon Shogo Fujita, Bank of America Merrill Lynch Domestic insurers, too, are not yet at the point of pain on their domestic bond holdings. It would take a drop below 0.5 per cent on the 10-year bond yield - or about 15bp below current levels - to start pushing people overseas, says Satoshi Shimamura, head of rates and markets in the investment strategy department at MassMutual, which manages about Y1.6tn of assets in Japan. Until then, insurers are likely to continue to build overseas assets very gradually, keeping JGBs as the cornerstone of their portfolios. "Lifers will continue to look to JGBs to match the duration of liabilities, and foreign bonds to match the coupon," says Shogo Fujita, chief Japanese bond strategist at Bank of America Merrill Lynch. A similar rationale applies to stocks. Prices have sagged in recent days but the Japanese market is still beating every other major index this year in local-currency terms, up a third. Satoshi Iwanaga, chairman of Eurekahedge, a Singapore-based research house owned by Mizuho Financial Group, says: "If you have Japanese stocks now, why would you switch?" Analysts note a few factors that could draw Japanese money overseas in coming months. The Government Pension Investment Fund, the world's largest pool of retirement savings with Y121tn in assets, is expected to reduce JGB holdings under a new strategy set out by an advisory panel which reports next month. The GPIF posted its smallest gain in three quarters in the three months to June on record domestic debt losses. "The current portfolio which emphasises domestic bonds should be reviewed to improve returns on investment," the panel said in an interim report last month. And under a new tax-efficient savings scheme debuting in January, retail investors could put more money outside Japan. According to Mizuho estimates based on early account-opening trends, annual investment in overseas stocks could amount to Y2.2tn. But for now, the big rebalancing is on ice. The fall in the yen over the past 12 months has been "very fast," says Masafumi Yamamoto, president of Praevidentia Strategy, a Tokyo-based consultancy. The decision-making of investors could not catch up to the change of reality.