Japan's central bank "butterfly effect" impact how big? Nomura: There may be over 100 billion US dollars flowing back to Japan, US bonds most affected.

At the end of July, the Bank of Japan surprised the market by announcing adjustments to its Yield Curve Control (YCC) policy, which has been implementing super loose monetary policy in recent years. The target range for 10-year Japanese government bond (JGB) yields remains unchanged at ±0.5%, but the wording has been changed to indicate that the upper and lower limits are only for reference and will be more flexibly controlled. Additionally, the daily yield level for purchasing 10-year JGBs has been raised from 0.5% to 1.0%.

The Bank of Japan's "sudden attack" swiftly shook the financial markets. On the day of the YCC adjustment announcement, the global bond market experienced widespread turmoil, with benchmark government bond prices plummeting and yields soaring. The 10-year JGB yield reached a new high not seen since 2014. A recent article on Wall Street CN pointed out that last week, long-term U.S. bond prices had their worst performance of the year, possibly due in part to the butterfly effect caused by the Bank of Japan's "sudden attack." This is because the major "patron" of U.S. bonds, Japanese investors, are looking to exit, and U.S. bonds will lose an important buyer.

Nomura Securities recently published a report analyzing the butterfly effect caused by the Bank of Japan's YCC adjustment. The report indicates that overseas investors are particularly concerned about whether Japanese investment will withdraw funds from overseas bonds and redirect them to domestic Japanese bonds. Nomura further analyzes key points such as the potential scale of the repatriation of Japanese capital.

Firstly, in terms of the scale of funds, since the Bank of Japan introduced QQE (Quantitative and Qualitative Monetary Easing) with YCC in 2013, the net cumulative total of overseas bond investments currently stands at 90.5 trillion yen, equivalent to approximately 630 billion U.S. dollars. Of this amount, 50.5 trillion yen, or about 350 billion U.S. dollars, comes from pension funds.

Nomura believes that unless the Government Pension Investment Fund (GPIF), Japan's largest pension fund, changes its basic investment portfolio, the investments of these pension funds will not shift from net buying to net selling.

So far, GPIF has not made any official statements indicating that the fund is considering changing the weight of its basic investment portfolio. In fact, throughout last year, GPIF did not reduce its exposure to overseas bonds.

Therefore, if the Bank of Japan's YCC adjustment triggers a repatriation of Japanese capital, it may affect a total fund size of approximately 40 trillion yen, equivalent to 280 billion U.S. dollars.

Now let's look at the indicator that influences Japanese investment funds. Based on recent fluctuations in Japanese investors' investments in overseas bonds, Nomura found a high correlation between the 20-year JGB yield and the net investment flow of overseas bonds. In other words, Japanese investors' investments in overseas bonds are often influenced by fluctuations in the 20-year JGB yield.

For example, when the 20-year JGB yield rose last year, Japanese investors continued to sell off foreign bonds. Although overseas bond investments have recovered this year, they have followed the trend of rising 20-year JGB yields, and investors have once again turned to selling foreign bonds.

According to Nomura's estimation, for every 10 basis points increase in the 20-year Japanese government bond (JGB) yield, Japanese investors would sell off approximately 1 to 2 trillion yen worth of overseas bonds. Assuming that the increase in overseas bond yields is limited and the yield on the 20-year JGB remains below 1.5% or even lower, the outflow of Japanese investors' domestic investment funds would be less than 10 trillion US dollars, equivalent to around 70 billion US dollars.

Nomura believes that since Japanese investors have hedged their exposure to overseas bonds to some extent, the impact of their capital repatriation on the yen may be limited. Overall, in this situation, the key factor affecting the yen exchange rate is the market's expectation of whether the Bank of Japan will raise short-term policy rates, rather than the impact of Japanese investment repatriation.

However, if the 20-year JGB yield rises above 2% due to higher overseas bond yields and the Bank of Japan takes aggressive steps towards normalizing its monetary policy, Nomura estimates that the scale of Japanese investors' capital repatriation could reach 10 to 20 trillion yen, equivalent to 70 to 140 billion US dollars. In this case, the positive impact on the yen cannot be ignored.

If the Bank of Japan abandons yield curve control (YCC) and allows the 10-year Japanese government bond yield to rise above 1%, the scale of Japanese investment fund repatriation and the upward impact on the yen could be amplified, as the market would be surprised by such a scenario and bond market volatility would increase. If this assumption of accelerated Japanese capital repatriation becomes a reality, the most likely reduction in exposure for Japanese investors would be in US bonds, as they account for the largest share, 46%, of their overseas bond exposure.