As Japan gradually narrows the interest rate gap with other countries due to the shift in ultra-loose monetary policy, the allure of "arbitrage trading" is fading, and Japanese investors' enthusiasm for overseas assets is gradually cooling.

The latest data shows that Japanese investors have net bought up to 28 trillion yen (approximately $192 billion) of Japanese government bonds in the first eight months of this year, reaching the highest level for the same period in at least 14 years. At the same time, their purchase of foreign bonds has decreased by nearly half to only 7.7 trillion yen, and the purchase of overseas stocks is less than 1 trillion yen.

This may mark the beginning of a new "super cycle." Arif Husain, fixed income chief at PIMCO with nearly thirty years of investment experience, pointed out: "Japanese investors' capital overseas will continue to flow back to Japan, gradually and on a large scale."

Against this backdrop, the market is particularly sensitive to the central bank's policies. BOJ Governor Haruhiko Kuroda has repeatedly hinted that policy normalization will proceed gradually, but the central bank will not rush to do so. Last night, newly elected Prime Minister Shizo Abe called for breaking out of deflation as the top priority for the Japanese economy, hoping the central bank will maintain its loose policy.

The attractiveness of domestic assets is increasing, with more and more investors inclined to repatriate funds to the Japanese market.

In recent years, Japanese investors have profited from the domestic ultra-low interest rate environment through the "carry trade" model, providing funding for the purchase of overseas assets. Japan's overseas investment amount reaches $4.4 trillion, larger than the size of the Indian economy.

However, as the Bank of Japan announces a rate hike, raising the policy rate from 0% to around 0.25%, the yield on benchmark 30-year Japanese government bonds has risen to above 2%. With the increasing attractiveness of domestic assets, more investors are inclined to repatriate funds to the Japanese market.

T&D Asset Management Co. stated that a 30-year government bond yield exceeding 2.5% could be a key point for capital flows back to the domestic market. Dai-ichi Life Insurance Company mentioned in April that yields on these bonds exceeding 2% would be relatively attractive.

For example, Japan Post Insurance company, although the company is still investing overseas, Masahide Komatsu, Senior General Manager of Global Crediting Investment Department, stated: "Investing in yen-denominated assets has become easier, and we hope to achieve investment diversification."

The trend of capital flowing back to Japan may continue.

Japanese investors' overseas layout once made them the largest foreign holders of US government ​bonds, controlling nearly 10% of Australian debt, and holding 1% to 2% market shares in stocks markets in Singapore, the Netherlands, and the USA.

However, the turmoil in the global markets, especially the major crash on August 5th, forced investors to reassess risks and returns. On that day, the Nikkei 225 index saw its largest drop since 1987, intensifying market volatility worldwide.

In the future, with policy adjustments by the Bank of Japan and the development of the global economic situation, the attractiveness of overseas assets is gradually declining, and the trend of capital flowing back to Japan may continue. According to JPMorgan's estimates, as many as three-quarters of arbitrage trades have been closed out. Charu Chanana, Global Market ​strategy Strate​gi​st at Shinsei Bank, stated:

"In August, we saw a trend of capital inflow. The Fed is committed to achieving a soft landing, reducing the chances of an economic recession. This indicates that future capital inflow may not be as sudden."

Shoki Omori, Chief Strategy ​strate​gi​st in Tokyo for SMBC Nikko Securities, said:

"Investors around the world have underestimated the risks of long-term massive capital repatriation. The Japanese themselves are large arbitrage traders. This trend has already begun—stay tuned."

Editor/Lambor