Author: Zhao Ying
The global market is underestimating a potential systemic risk—Japan. As the yen falls to multi-decade lows and the appeal of domestic Japanese assets rises, the world's largest pension fund is facing policy pressure to repatriate its massive asset holdings back to Japan on a large scale. Once this process begins, the US stock market, bond market, and the US dollar may come under simultaneous pressure.
Recently, Japanese Prime Minister Takaichi Sanae stated that the government will promote the Government Pension Investment Fund (GPIF) and other national pension funds to increase their investment in domestic Japanese financial assets. Finance Minister Katayama Satsuki previously gave a similar signal. Although the GPIF has not announced any formal asset allocation adjustments, the market has already begun to assess its potential impact: if the fund repatriates its overseas holdings back to Japan, US Treasury yields may rise, the US dollar may weaken, and risk assets may come under pressure.
Currently, the market's pricing of the aforementioned risk remains relatively calm, but some technical indicators are already showing subtle changes, and investors should not be complacent.
The $1.8 Trillion Variable
The GPIF manages approximately $1.8 trillion, with domestic and foreign assets each accounting for about half, of which its overseas holdings total about $930 billion. In recent years, the fund's holdings of Japanese government bonds have decreased from about $770 billion to about $515 billion, while its holdings of foreign bonds have increased from about $128 billion to about $470 billion.
This structural change means that even a small-scale asset reallocation could trigger significant waves in the global market. According to a MarketWatch report, analyst Michael Kramer pointed out that if the GPIF repatriates some of its overseas assets back to Japan, it will directly boost demand for the yen and introduce a massive buying wave into the Japanese government bond market—a positive for Japan, but for the US, it implies higher interest rates and a weaker dollar.
At the same time, any large-scale unwinding of yen carry trades (i.e., borrowing low-interest yen, converting to US dollars, and investing in US assets) would further pressure the performance of risk assets.
Yen and JGBs: The Appeal of Domestic Assets Is Rising
Driving the potential GPIF reallocation is a substantial improvement in the fundamentals of Japanese domestic assets. With Japan's inflation recovering and economic growth resuming, the appeal of domestic investment opportunities has significantly increased. In February, the yield spread between US and Japanese two-year government bonds narrowed to its lowest level since early 2022.
At the same time, the yen has continued to weaken, with USD/JPY breaking above 163, reaching its highest level since 1986. From a technical analysis perspective, if the exchange rate rises further, the next resistance level is around 176. According to a report by the Financial Times, Fredrik Repton of Neuberger Berman believes that if GPIF allocates more funds to domestic assets, this could be a "very elegant solution" to Japan's macroeconomic problems, but other domestic financial institutions would also need to follow suit, and "this process will take a long time."
Japan's 10-year government bond yield recently touched 2.7%, the first time in 30 years. Deutsche Bank analyst Mallika Sachdeva pointed out in a recent report that the focus of Japanese authorities' policy may be shifting from exchange rate management to yield management, and if this shift materializes, it will put further pressure on the yen.
Market Not Yet Pricing It In, But Signals Are Emerging
Currently, the global market's reaction to the risk of Japanese capital repatriation remains relatively restrained. The five-year USD/JPY cross-currency basis swap recently stood at about minus 30 basis points, the narrowest level since this data series began in 2021, indicating that the market's hedging demand for a stronger yen has not yet risen significantly.
However, this indicator itself is a key signal for observing whether capital flows are beginning to shift. Historical data shows that the S&P 500 index and the cross-currency basis swap have moved in sync during multiple periods—whenever hedging demand rises sharply, the US stock market often declines as liquidity tightens accordingly. Once market expectations for yen appreciation heat up, the demand for USD hedging will climb accordingly, and the liquidity tightening effect will become more pronounced.
Japanese Stocks: The Other Side of the Risk
It is worth noting that while the potential asset reallocation by GPIF may bring pressure to US markets, it also provides a new narrative logic for Japanese stocks. The Japanese stock market is benefiting from drivers that are distinctly different from those in the US market: the concentration of the technology sector in the Topix index is much lower than in the S&P 500, its exposure to artificial intelligence is relatively limited, and its valuation still trades at a discount of more than 20% compared to the S&P 500.
Corporate governance reform is a core catalyst for Japanese stocks. Dan Rasmussen of Verdad Advisers points out that there are still about 1,000 companies in Japan whose stock prices are below book value, and among the cheapest quintile of companies, cross-shareholdings still account for about 40% of their market capitalization. As cross-shareholdings are gradually unwound, a large amount of historically accumulated profits is expected to be released, having a materially positive impact on corporate earnings.
However, for foreign investors, the persistently weakening yen is the biggest obstacle—over the past two years, yen depreciation has significantly eroded the real returns of foreign capital in the Japanese stock market. How to handle currency hedging, and whether the hedging cost is bearable, remain core issues facing global investors.
