Synopsis:

As Japan’s new fiscal year begins, BofA expects structural capital outflows to persist, with lifers selectively re-entering foreign bond markets, particularly hedged EUR-denominated debt. Meanwhile, unhedged flows are likely to favor buying dips in USD/JPY and EUR/JPY, with EUR/JPY especially supported by Europe’s fiscal expansion and attractive yield differentials. On the rates side, BofA sees scope for JGB curve flattening, especially in the superlong end.

Key Points:

1️⃣ Structural Outflows to Continue 🌍📤

• Japanese investors, particularly life insurers, will likely resume foreign bond buying, though cautiously.

• Preference is for hedged EUR bonds, while unhedged dips in USD/JPY and EUR/JPY are likely to attract demand.

2️⃣ EUR/JPY Supported by Europe’s Fiscal Outlook 💶🔼

• Europe’s fiscal expansion and bond issuance continue to attract Japanese investor interest.

• Structural outflows + EUR demand = tailwind for EUR/JPY upside.

3️⃣ FX and Rates Trade Recommendations 📊💱

• Buy 1yr EUR/JPY call to express bullish view on currency pair.

• Initiate 10s20s JGB curve flattener—expecting superlong JGB demand to return as yield spike moderates.

4️⃣ BoJ Uncertainty Keeps Long-Term Demand Cautious 🏦❓

• While lifers may return to the superlong end, intermediate and long-dated JGB demand remains tentative, as markets assess BoJ’s terminal rate and inflation trajectory.

Conclusion:

BofA expects Japan’s fiscal year reset to reignite structural outflows, with EUR/JPY benefiting most from portfolio reallocation and Europe’s fiscal backdrop. On the domestic front, curve flatteners in JGBs are favored, especially as superlong demand may re-emerge. Uncertainty around BoJ policy may limit the breadth of domestic bond demand, but selective foreign bond appetite and FX positioning offer compelling trades