Asian bond investors return to European shores as U.S. loses luster

LONDON (Reuters) - Asian investors are returning to the European government bond market in numbers not seen in years, as a strengthening economy, positive yields and the increasing cost of dollar investments conspire to make Europe an attractive destination again.

Data shows Asian buyers making up a larger proportion of investors in recent government and government-linked bond sales than they have for years, having largely shunned a market that was offering record low yields.

For instance, a good chunk of recent bond sales by Belgium, Sweden and European government-backed borrowers such as the European Investment Bank and Germany’s KfW was sold to Asia.

In Belgium’s recent 4.5 billion euro sale of 15-year bonds, 12 percent — or 540 million euros — was bought by Asian investors and earlier in the year Asians accounted for 16.3 percent of the demand for the country’s 10-year bond sale, allowing it to sell a record 5 billion euros of debt.

That’s a far cry from last year when Belgium sold 1 percent or less of bond issues to Asian buyers.

While many assumed that Asian investors would return to the euro zone market as worries over the break-up of the bloc recede, both the data and comments from traders suggest buyers are returning in larger numbers than expected.

“Some of the (Asian) investors we are speaking to now are those we haven’t spoken to in years,” said one senior London-based banker who manages bond sales for several European governments.

“They are now coming back now that Europe is on a positive trajectory and the yields are no longer so low but also you have to be worried about U.S. Treasuries, given the huge amount of borrowing being undertaken by the Trump administration and all this talk around trade wars,” he said.

He wanted to remain anonymous as he is not authorized to speak about his clients.

Another banker who works in a similar capacity for a rival institution said that typical investors in this space include the central banks of larger Asian countries such as China, India, Indonesia and Philippines, large banks from across the continent and asset managers from countries such as Japan.

Of all these countries, Japanese investor data is the most readily available.

Figures from the Japanese finance ministry showed net purchases of euro-denominated bonds by Japanese investors hit the second-highest level on record, confirming money managers were accelerating their shift to Europe and away from U.S. debt..

EUROPEAN ATTRACTION

The Asian buying surge could not come at a better time for Europe. It should help cap borrowing costs just as the European Central Bank prepares to withdraw support for the bond market.

This will give euro zone countries some breathing space as they tackle unprecedented levels of public debt incurred through the series of recent debt crises.

One factor driving the flows back to Europe is that the cost of hedging euro exposure is currently lower than hedging dollar risk - crucial for bond investors, who need to guard against currency swings.

“The attraction of hedged dollar bonds has diminished significantly,” said Hiroshi Ozeki, chief investment officer at Nippon Life, one of Japan’s largest institutional investors.

“We probably will no longer buy U.S. Treasuries with currency hedging. On the other hand, euro-denominated bonds are attractive in terms of hedging as we can earn premium instead of costs.”

A gauge measuring three month yen/dollar forward rates JPY3M=, a derivative often used for hedging currency exposure, is close to its highest since the 2008 financial crisis barring a brief spike at the end of last year. The yen/euro equivalent EURJPY3M= is far steadier.

“In recent months given how US rates have been going up the hedging costs there have gone up too. We have a couple of Japanese clients who are talking of moving money from the US to Europe and the main reason given is the hedging cost,” Roberto Coronado, Senior Portfolio Manager, Investment Grade Credit, PineBridge Investments

Peter Chatwell, head of rates at Mizuho International, the investment banking arm of Japan’s second largest bank, pointed to the underperformance of U.S. government bonds compared to European, as a symptom of this.

The gap between short-dated German and U.S. bond yields — which move inversely to price — is at their widest in over 20 years.

France and Germany have not conducted any recent bond syndications where a geographical breakdown of the investor base was revealed.

But German state-guaranteed development KfW, often seen as a proxy for sovereign debt, this week sold 18 percent of a 4 billion euro sale of five-year bonds to Asian investors and EU-backed European Investment Bank sold 11 percent of a 5 billion euros 10-year deal to Asian investors.