May 10, 2018 / 10:02 AM / 13 days ago

UPDATE 1-Japanese investors buy record amount of Spanish bonds in March

(Updates with detail, comment)

By Hideyuki Sano and Dhara Ranasinghe

TOKYO/LONDON, May 10 (Reuters) - Japanese investors bought a record 282.1 billion yen ($2.57 billion) of Spanish bonds in March, Japanese government data showed on Thursday, highlighting increased foreign demand for euro zone debt.

Net Japanese buying of Spanish bonds surpassed a previous record of 199.7 billion yen marked in October 2005, the data showed.

Overall, the data reflected continued buying of euro zone bonds, with 901.8 billion yen worth of euro-denominated bonds purchased in March.

Japanese bond investors have forayed abroad in increasing numbers in recent years as the Bank of Japan’s aggressive monetary easing keeps domestic bond yields at record lows .

Yet most Japanese institutional investors want to avoid being exposed to currency market fluctuations and typically have currency hedging on a large part of their foreign bond portfolio.

The cost for dollar hedging, which is closely tied to dollar interest rates, has been steadily rising since 2014. The rise accelerated last year as investors priced in faster rate increases by the U.S. Federal Reserve, in turn encouraging foreign investors into euro zone bond markets.

Analysts say this development, in particular, has boosted demand for peripheral government bonds - coinciding with ratings upgrades and brighter growth prospects.

Spain’s 10-year bond yield gap over Germany is at 75 basis points, compared with 115 bps at the end of last year .

“Increased appetite for Spanish bonds shows there’s now a de-correlation of peripheral government bonds from risk assets,” said Lyn Graham-Taylor, a rates strategist at Rabobank in London. “Investors are loving the carry story.”

Another strategist, who asked not be named, said he suspected that ratings upgrades for Spain may also have encouraged Japanese buying of Spanish bonds.

S&P Global in March raised Spain’s credit rating to A- from BBB+, citing a positive outlook for the economy and budgetary consolidation, marking the second ratings upgrade of the year .

French bonds, historically a favourite among Japanese investors, are offering a limited yield pick-up, so a diversification into peripheral bonds by foreign investors can be expected, analysts added.

Japanese investors sold French bonds in March, the data showed. (Reporting by Hideyuki Sano in Tokyo and Dhara Ranasinghe in London; editing by Sujata Rao and Larry King)

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