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Here's why foreign demand for US bonds will remain strong - regardless of what Japan does, according to Goldman Sachs

Biden and Janet Yellen
U.S. Treasury Secretary Janet Yellen listens to President Joe Biden in the South Court Auditorium in the Eisenhower Executive Office Building on October 06, 2021.Chip Somodevilla/Getty Images
  • Demand for US bonds from foreign buyers will remain strong, according to Goldman Sachs.

  • Goldman said it expects a solid appetite from foreigners for US bonds even as Japan phases out its yield curve control policy.

  • "Lack of domestic alternatives will likely continue to put a floor on foreign net purchases," Goldman said.

Foreign buyers will continue to have a strong appetite for US bonds, even as Japan begins to phase out its yield curve control policy, according to Goldman Sachs.

As a form of quantitative easing, Japan's central bank has kept a lid on short- and medium- term interest rates since 2016, making its safe-haven bond market less appealing to investors over the past few years as interest rates have surged.

But Japan — a major buyer of US bonds — is now phasing out its yield curve control program amid an ongoing normalization of its monetary policy, and that's sparked fear among investors that foreign buyers could begin to look to Japan's bond market as an alternative to the US.

If demand does drop, it would be significant as Goldman Sachs says foreigners owned $4.1 trillion of US corporate bonds at the end of August, representing an estimated 42% of the entire US investment grade and high-yield bond market.

"The market value of these holdings peaked in mid-2021 at $4.7 trillion, which corresponds to the post-COVID trough in long-dated Treasury yields," Goldman said.

But even with a strong US dollar and elevated funding and hedging costs, foreign buyers purchased $130 billion in US corporate bonds in the first eight months of the year.

And despite a recent uptick in Japanese yields, the 10-year US Treasury rate at 4.68% is still more than four times the current 10-year Japanese yield of 0.92%. Meanwhile, the US corporate bond yields are currently just below 6%, compared to just under 1% for Japanese corporate bonds.

"The depth and the breadth of US credit markets coupled with the lack of competing domestic alternatives will likely continue to put a floor on foreign net purchases," Goldman Sachs said.

On top of that, Japan's ongoing normalization of its monetary policy likely won't be enough to nudge foreign buyers away from the US bond market, as there are many moving parts to the policy that offer different incentives to different investors.

And any selling pressure in the US bond market by foreign investors would have to be driven by a confluence of different factors.

"Conceptually, a combination of significant Yen strengthening, a sharp steepening of the JGB yield curve and significant compression of the yield differential with USD bonds could fuel persistent selling pressure. But the bar is, however, remarkably high, given current market pricing," Goldman said.

Read the original article on Business Insider