Richard Davies
Robin Marshall
- The carry effect of hedging yen exposure in Japanese Government Bonds (JGBs) back into US dollars, and spot yen weakness, drove strong returns in 2023.
- The return differential between a USD unhedged, and USD hedged position in JGBs was 10.3% to end-July 2023.
- These returns far exceeded local currency returns in Treasuries and JGBs.
JGB returns hedged into US dollars have performed very strongly in 2023….
…reflecting weakness of the yen versus the US dollar
Why is this? Table 1 shows the yen spot rate fell against the dollar by over 7% in the first 7 months of 2023, rather than appreciated, which the forward rate differentials in favour of the dollar would have implied by covered interest parity.
Table 1: Japanese govt bond index returns yen/USD FX return
| Month | Local Return | Spot Return | Forward Return |
|---|---|---|---|
| 31-Jan-23 | -0.44% | 1.46% | -1.06% |
| 28-Feb-23 | 1.68% | -4.53% | 4.91% |
| 31-Mar-23 | 2.11% | 2.35% | -1.92% |
| 30-Apr-23 | 0.34% | -2.26% | 2.69% |
| 31-May-23 | -0.14% | -2.54% | 3.01% |
| 30-Jun-23 | 0.30% | -3.33% | 3.81% |
| 31-Jul-23 | -2.16% | 1.73% | -1.26% |
| YTD | 1.65% | -7.13% | 10.53% |
Source: FTSE Russell. Past performance is no guarantee to future results. Please see the end for important disclosures
As a result, forward returns for a US dollar-based investor, who sold the yen forward to hedge yen exposure in JGBs, reached an impressive +4.71% as of July 2023. The returns were even higher, at 6.5%, at the end of June 2023, as Table 2 shows, before the BoJ’s switch to more flexible yield curve control, announced on July 28, which caused the yen to rally against the US dollar, as the spot returns show in Table 1. In contrast, a US investor in US treasuries would have made a return of only +1.48% for the same period.
Dollar/yen carry effects have become sizeable after 525bp of Fed tightening
Table 2 also shows currency hedging a portfolio both removes the spot currency exposure (in yen in this case), and, through the carry effect, allows access to the higher foreign currency interest rate (in US dollars in this case). Recent widening in US/Japan interest rate differentials has increased this carry effect substantially, after 525bp of Fed tightening since March 2022, whilst the BoJ has retained -0.1% short rates, and 10 yr JGB yields capped at 0.5% (and 1% since July 28). Thus, the return differential between a USD unhedged, and USD hedged position in JGBs has been a cumulative 10.3% for the year to date.
Table 2: Japan Government Bond Index returns
| Month | Month-to -date local | Month-to -date USD unhedged | Month-to-date USD hedged | Cumulative Difference in returns Year-to-date |
|---|---|---|---|---|
| 31-Jan-23 | -0.40% | 1.00% | 0.00% | |
| 28-Feb-23 | 1.70% | -2.90% | 2.00% | |
| 31-Mar-23 | 2.10% | 4.50% | 2.60% | |
| 30-Apr-23 | 0.30% | -1.90% | 0.80% | |
| 31-May-23 | -0.10% | -2.70% | 0.30% | |
| 30-Jun-23 | 0.30% | -3.00% | 0.80% | |
| 31-Jul-23 | -2.20% | -0.50% | -1.70% | |
| Year-to-date | 1.65% | -5.60% | 4.71% | 10.30% |
Source: FTSE Russell. Past performance is no guarantee to future results. Please see the end for important disclosures.
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