Feb. 12 (Bloomberg) -- Bond investors in Japan, the biggest sellers of U.S. government debt last year, are returning to Treasuries as the dollar gains and yields rise.
Fuji Investment Management Co., which oversees the equivalent of $10.8 billion, boosted Treasuries in its global bond holdings to 40 percent from 30 percent in December, anticipating slower U.S. economic growth. Daiwa Asset Management Co., Japan's second-biggest money manager, is buying 10-year U.S. notes.
``The place to be is the Treasury market,'' said Akira Takei, a money manager at Fuji, a Tokyo-based unit of Mizuho Financial Group Inc., Japan's second-largest bank. ``The rally will resume in the bond market.''
The combination of a rally in Treasuries and a 2.2 percent gain in the dollar this year boosted demand from Japan's investors, who reduced holdings of U.S. government debt for a second year in 2006 in favor of higher-yielding corporate bonds and securities from Fannie Mae and Freddie Mac, Treasury Department data show.
Yields on 10-year notes fell 4 basis points, or 0.04 percentage point, to 4.78 percent last week as the Treasury sold $38 billion of three- and 10-year notes and 30-year bonds. Ten- year yields dropped 11 basis points since climbing to the highest in almost six months on Jan. 29. They were little changed today.
Japanese investors sold $32.6 billion of Treasuries in the first 11 months of last year, cutting their holdings to $637.4 billion, according to the Treasury Department. Taiwan was the next largest seller, trimming $4.9 billion.
Higher Yields
The 10-year note yields 3.09 percentage points more than Japan's 1.7 percent benchmark bonds due in 2016. That spread increased from 2.81 percentage points on Dec. 7.
``The interest-rate differential is very attractive,'' said Naruki Nakamura, who helps oversee about $41.5 billion at Fischer Francis Trees & Watts Inc. in Tokyo. ``It is quite natural that Japanese are willing to invest abroad, where they can expect higher growth.''
Japanese demand declined in 2006, when the Bank of Japan raised interest rates for the first time in almost six years and speculation increased that the Federal Reserve would reduce its target rate for overnight loans between banks in the first half of 2007.
Interest Rate Expectations
Interest-rate futures suggest the Fed won't cut interest rates at least until the end of the third quarter. Japanese officials, including central bank policy board member Hidehiko Haru on Feb. 8, said there's no rush to raise rates.
The U.S. economy grew at an annualized 3.5 percent in the fourth quarter, compared with the 3 percent forecast by economists in a Bloomberg survey.
The Fed has held its target rate at 5.25 percent since June. The European Central Bank has kept its benchmark rate at 3.5 percent since raising it in December. The Bank of Japan's key lending rate is 0.25 percent.
Japanese interest rates, the lowest in the world among industrialized nations, have made the country a favorite financing source for hedge funds and money managers pursuing the so-called carry trade, where they borrow yen and sell the currency to invest in countries with higher interest rates.
The carry trade has become more attractive because of an unanticipated advance in the dollar. Only three of 40 analysts Bloomberg surveyed in December 2006 forecast a gain for the dollar against the yen. Instead, the dollar's value rose to 121.66 yen from 119.05 yen at the end of last year.
Treasury Auctions
Demand from international investors at last week's Treasury auctions was stronger than prior government debt sales.
So-called indirect bidders, a category that includes foreign investors, bought 42.1 percent of the $9 billion of 30-year bonds sold Feb. 8 and 32.3 percent of the three-year notes sold Feb. 6, the most since May 2005. Demand for the $16 billion of three-year notes, at a yield of 4.8 percent, was higher than forecasts by dealers. Bidding for the $13 billion of 10-year notes sold Feb. 7 was above the average for the previous 12 auctions.
Auction data give a ``fairly good proxy'' for foreign purchases of Treasury notes, according to a study by the Federal Reserve Bank of New York released Feb. 7.
Japanese investors can push Treasury prices up or down because they hold about 13 percent of U.S. debt, said T.J. Marta, a fixed-income strategist at RBC Capital Markets in New York.
Kokusai Asset Management Co., manager of the world's second- largest bond fund, is among the bulls. The firm owns a larger proportion of Treasuries and fewer bonds denominated in yen than in its benchmark index. The firm increased holdings of Treasuries to 28 percent of assets in September from 26 percent in June.
``U.S. interest rates are getting more attractive,'' said Masataka Horii, who helps manage the Kokusai Global Sovereign Open fund in Tokyo. The fund has $46.3 billion in assets, the most after Pacific Investment Management Co.'s Total Return Fund, run by Bill Gross.
To contact the reporters on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net ; Daniel Kruger in New York at dkruger1@bloomberg.net
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