Japan, not artificial intelligence or war, may be the risk global markets are paying too little attention to. With the yen near multi-decade lows and domestic assets in Japan looking more attractive, investors are starting to weigh a scenario in which large pools of Japanese capital move back home. If that process gathers pace, U.S. equities, Treasuries and the dollar could all face pressure.
Prime Minister Sanae Takaichi recently said the government would push Japan’s Government Pension Investment Fund, or GPIF, along with other state pension funds, to increase investment in domestic financial assets. Finance Minister Satsuki Katayama had sent a similar signal earlier. GPIF has not announced any formal change to its asset allocation, but the market has already begun to model the possible fallout: if overseas holdings are redirected into Japan, Treasury yields could rise, the dollar could weaken and risk assets could come under strain.
A $1.8 trillion portfolio with global reach
GPIF manages about $1.8 trillion, with domestic and foreign assets split roughly in half. Its overseas holdings total about $930 billion. Over recent years, the fund’s portfolio mix has already shifted in a meaningful way. Its holdings of Japanese government bonds fell from about $770 billion to around $515 billion, while foreign bond exposure climbed from about $128 billion to roughly $470 billion.
That change in structure means even a relatively small reallocation could move markets. According to MarketWatch, analyst Michael Kramer said that if GPIF brings part of its overseas assets back into Japan, demand for the yen would rise directly and Japanese government bonds would see substantial buying. That would be supportive for Japan, but for the United States it could translate into higher rates and a weaker dollar.
There is another transmission channel as well: the yen carry trade. Investors that borrow cheaply in yen, convert into dollars and buy U.S. assets could be forced to unwind those positions on a larger scale. If that happens, risk assets would likely face added pressure.
Why domestic Japanese assets are starting to look stronger
The backdrop for any potential GPIF reallocation is an improvement in Japan’s domestic fundamentals. Inflation has picked up, economic growth has recovered and local investment opportunities look more compelling than they did before. In February this year, the yield gap between U.S. and Japanese two-year government bonds narrowed to its smallest level since early 2022.
At the same time, the yen has kept weakening. USD/JPY moved above 163, the highest level since 1986. From a technical perspective, if the pair keeps rising, the next resistance level is seen near 176. The Financial Times cited Fredrik Repton of Neuberger Berman as saying that if GPIF allocates more money to domestic assets, it could be a “very elegant solution” to Japan’s macro problems. He also said other domestic financial institutions would need to follow, and that “the process will take a very long time.”
Japan’s 10-year government bond yield recently touched 2.7% for the first time in 30 years. In a recent report, Deutsche Bank analyst Mallika Sachdeva said Japanese policymakers may be shifting their focus from managing the exchange rate to managing yields. If that proves correct, the yen could come under even more pressure.
The market has not priced it in, but the signals are visible
For now, global markets remain relatively restrained in how they are pricing the risk of Japanese capital returning home. The five-year USD/JPY cross-currency basis swap has recently been around negative 30 basis points, the narrowest level in the series since it was introduced in 2021. That suggests hedging demand for yen appreciation has not yet risen in a pronounced way.
Still, that metric is itself an important gauge of whether capital flows are beginning to change direction. Historical data show that the S&P 500 and the cross-currency basis swap have moved together during several periods. When hedging demand rises sharply, U.S. equities have often fallen as liquidity tightens. If expectations for a stronger yen start to build, demand for dollar hedges would likely increase as well, making the tightening effect more visible.
Japanese stocks present the other side of the trade
A potential GPIF reallocation may create stress for U.S. markets, but it also offers a different investment case for Japan’s equity market. Japanese stocks are being driven by factors that differ from those behind the U.S. rally. The technology sector in the Tokyo Stock Price Index, or Topix, is much less concentrated than the S&P 500, has more limited artificial-intelligence exposure and still trades at a discount of more than 20% to the S&P 500 on valuation.
Corporate governance reform remains a central catalyst. Dan Rasmussen of Verdad Advisers said about 1,000 Japanese companies still trade below book value. Among the cheapest fifth of listed companies, cross-shareholdings still account for about 40% of market capitalization. As those holdings are unwound over time, accumulated profits from the past could be released and provide a real boost to corporate earnings.
For overseas investors, however, the weak yen remains the biggest obstacle. Over the past two years, yen depreciation has significantly eroded real returns for foreign money invested in Japanese equities. How to manage currency hedging, and whether the cost of that hedge is acceptable, remains a core question for global investors.