Overseas investors recorded the second-highest net purchases of Japanese government bonds in history during January, as elevated yields sufficiently offset concerns over potential fiscal expansion risks. Data released by the Japan Securities Dealers Association on Friday showed foreign investors bought a net 6.04 trillion yen (approximately $389 billion) worth of Japanese government bonds during the month, a figure second only to the record 6.08 trillion yen seen in March 2023.

Japanese bond yields reached a recent peak on January 20, following an announcement by Prime Minister Sanae Takaichi the previous day that she would dissolve the lower house for a general election and pledged a temporary reduction in the food consumption tax. Yields subsequently retreated as the ruling party secured a decisive victory, easing market expectations of significant fiscal spending aimed at appeasing voters.

Ryutaro Kimura, senior fixed income strategist at AXA Investment Managers, noted that foreign investors appeared to be actively increasing their allocations to Japanese bonds during the yield uptrend. He added that the buying activity indicated, at least partially, global asset managers' expectation that the Takaichi administration would refrain from pursuing reckless fiscal expansion policies.

The data also revealed a divergence in behavior between domestic and foreign investors. Japanese insurance companies reduced their holdings of super-long-term bonds by 721.8 billion yen, marking the second-largest reduction on record, surpassed only by December of the previous year. Meanwhile, regional banks sold super-long-term bonds at a record pace in January.

Last year, overseas investors emerged as the largest buyers of Japan’s super-long-term bonds, underscoring their growing influence in a market traditionally dominated by domestic investors and the Bank of Japan. Rahul Anand, the International Monetary Fund’s mission chief for Japan, stated this week that there was no evidence suggesting foreign demand for Japanese bonds had diminished due to fiscal concerns.

According to Shuichi Ohsaki, senior investment manager at Meiji Yasuda Asset Management Co., foreign investors are building flattener positions—shorting short-term bonds while buying long-term bonds. This strategy is based on expectations that issuance of super-long-term bonds will decline starting in April, and that this segment is less sensitive to potential interest rate hikes by the Bank of Japan. However, Ohsaki cautioned that foreign investors may begin unwinding these positions once the actual reduction in issuance takes effect in April.