Author: Zhao Ying
The global market is underestimating a potential systemic risk—Japan. As the yen falls to multi-decade lows and the attractiveness of Japanese domestic assets rises, the world's largest pension fund is facing policy pressure to repatriate assets on a massive scale. Once this process begins, the US stock market, bond market, and the US dollar could simultaneously face pressure.
Recently, Japanese Prime Minister Takaichi Sanae stated that the government will encourage the Government Pension Investment Fund (GPIF) and other national pension funds to increase investment in Japan's domestic financial assets. Finance Minister Katayama Satsuki had previously signaled similar intentions. Although GPIF has not announced any formal asset allocation adjustments, the market has begun to assess its potential impact: if the fund repatriates its overseas holdings, US Treasury yields could rise, the US dollar could weaken, and risk assets could come under pressure.
Currently, the market's pricing for the above risks remains relatively calm, but some technical indicators are already showing subtle changes. Investors should not be complacent.
The $1.8 Trillion Variable
GPIF manages about $1.8 trillion, with domestic and foreign assets each accounting for roughly half. 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 modest asset reallocation could trigger significant volatility in global markets. According to MarketWatch, analyst Michael Kramer points out that if GPIF repatriates some overseas assets, it would directly boost demand for the yen and introduce large-scale buying into the Japanese government bond market—a positive for Japan, but implying higher interest rates and a weaker dollar for the US.
At the same time, a large-scale unwinding of yen carry trades (borrowing low-interest yen, converting to dollars, and investing in US assets) would further weigh on the performance of risk assets.
Yen and JGBs: Rising Attractiveness of Domestic Assets
Driving GPIF's potential reallocation is a substantial improvement in the fundamentals of Japanese domestic assets. As Japan's inflation recovers and economic growth resumes, the appeal of domestic investment opportunities has increased significantly. In February of this year, the spread between US and Japanese two-year government bond yields narrowed to its lowest level since early 2022.
At the same time, the yen continues 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 the Financial Times, Fredrik Repton of Neuberger Berman believes that if GPIF allocates more funds to domestic assets, it could be a "very elegant solution" to Japan's macro problems, but other domestic financial institutions would also need to follow suit, and "this process would take a very long time."
Japan's 10-year government bond yield recently touched 2.7%, the first time in 30 years. Deutsche Bank analyst Mallika Sachdeva noted in a recent report that the focus of Japanese authorities' policy may be shifting from exchange rate management to yield management. If this shift materializes, it would put further pressure on the yen.
The Market Hasn't Priced 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 around minus 30 basis points, the narrowest level since the data series began in 2021, indicating that the market's demand to hedge against yen appreciation has not 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 cross-currency basis swaps have moved in tandem during multiple periods—when hedging demand rises sharply, US stocks often fall as liquidity tightens. Once market expectations for yen appreciation heat up, demand for dollar hedging will climb, and the liquidity tightening effect will become more pronounced.
Japanese Stocks: The Other Side of the Risk
It is worth noting that GPIF's potential asset reallocation, while bringing pressure to the US market, also provides a new narrative for Japanese stocks. The Japanese stock market is benefiting from drivers quite 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 over 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. Among the cheapest one-fifth of companies, cross-shareholdings still account for about 40% of their market value. As cross-shareholdings are gradually unwound, a large amount of historically accumulated profits is expected to be released, providing a substantive positive impact on corporate earnings.
However, for foreign investors, the persistently weak yen is the biggest obstacle—yen depreciation over the past two years has significantly eroded the real returns for foreign capital in Japanese stocks. How to handle currency hedging, and whether the cost of hedging is bearable, remain core issues facing global investors.
