Should I Invest in US Dollar-Denominated Bonds Amid the Weak Yen? [Customer Question Series ①]

Hello, I am Taisei Fujimura (
https://twitter.com/wp_fujimura) and I am an IFA for high-net-worth individuals at Wealth Partner (https://wealth-partner-re.com/).

Recently, I have been receiving more questions like “I am worried about whether I should invest in US dollar-denominated bonds because while interest rates are high, the yen is weak.” To give you my conclusion,
“You should buy bonds while interest rates are high rather than worrying about exchange rates.” I would like to write about the reasons for this today.

(1) Opportunity loss of income gains occurs

Unlike stocks, bonds pay interest based on the number of days held.
For example, if you buy a bond with a 5% interest rate for 100 million yen, you will receive 5 million yen (pre-tax) in income gains, but what happens if you worry about whether to buy it and six months pass?
100 million yen × 5% interest rate × 1/2 year = 2.5 million yen (pre-tax), meaning you lose out on about 2.5 million yen for that half-year period.
No one knows what will happen to future exchange rates or interest rate levels. If you have firm confidence in your market outlook, I think it is fine to time your investment.

(2) By continuing to invest, the break-even exchange rate decreases

Since the annual income gain and yield are fixed when you buy a bond, the longer you hold it, the more income gains will reliably accumulate, and the break-even exchange rate will decrease.
The chart below shows the break-even exchange rate when buying a bond with a 5% yield when the exchange rate is 150 yen. It is calculated that you can withstand a yen appreciation to 117.52 yen after 5 years and 92.08 yen after 10 years.

I do not know how the exchange rate will move in the future, but since it tends to weaken in the long term, I think it is unlikely that a strong yen below 100 will continue. Also, by increasing the ratio of long-term bonds while interest rates are high, you can lock in the yield for a long period, and during that time, the break-even exchange rate will steadily decrease. At the current yield level (as of 2023/7/3), it is not difficult to build a bond portfolio with a 10-year investment yield of 5%.

(3) Because when the yen appreciates, US interest rate levels are also likely to fall

It would be best if you could buy bonds when the yen is strong and US interest rates are high, but reality is not that simple.
Interest rates and exchange rates often move in tandem. The reason for a stronger yen is “because the yen is bought due to the narrowing of the Japan-US interest rate gap as US interest rates fall,” which means that when interest rates are high, the exchange rate is also high, and when the exchange rate is low, interest rates are often low as well. Simply put, there is a relationship where when one is good, the other is bad. There was an event that symbolized this in the past year. The chart below is a one-year chart of the dollar-yen and the US 10-year Treasury yield.

I think last November is still fresh in our memories. It was when the US 10-year Treasury yield hit the 4% range and the exchange rate was 150 yen. It seems like it was a buying opportunity as bond yields rose, but I think many people were worried about whether they should buy bonds as the yen weakened to 150.

An exception is the pattern where the yen strengthens due to factors unique to Japan. In the chart above, that is around last December to February. US interest rates did not move that much, but the exchange rate swung sharply toward a stronger yen after the Bank of Japan made comments about revising YCC. In such times, you can buy bonds under good conditions of “a strong yen and high US interest rates.”
However, it is difficult to predict the timing of the Bank of Japan's monetary policy shift, and waiting for a yen appreciation due to Japanese factors will also result in opportunity loss.
Rather than waiting for something that you do not know when it will come, I think it is better to lock in a high yield while you can, as investing will lower your break-even exchange rate.

(4) Conclusion

This time, I used a question I received from a customer regarding US dollar-denominated bond investment while the yen is weakening as an example. I hope this helps with bond investment in difficult situations.

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