US Bond Yields Soar – Japanese Bond Market Meltdown – Yen Carry Trade? Capital Repatriation Event?

US Bond Yields Soar – Japanese Bond Market Meltdown – Yen Carry Trade? Capital Repatriation Event?

US government bond yields are soaring. There’s a big problem and it’s coming out of Japan where their bond market continues to absolutely melt down risking not only trillions of capital unwinding in the end carry trade but a capital repatriation event causing trillions in US stock and bond sales. So there’s a lot going on. Major moves in the US bond market, major moves in the Japanese government bond market as well. A lot of uh pretty large risks on the horizon. So I wanted to address them in this video specifically looking at the interlink between Japan and the US and try to explain it best I can. So here’s the 10-year JGB yield right now almost at 2% uh for the first time in decades. Now here is the root of the problem. Japan has run a current account surplus. Remember the vast majority of that is balance of trade. They run a trade surplus. we can see uh recently has been as high as almost 5% of GDP. They run a very very strong economy exportdriven economy. Well, the other side of that coin means that they must run a capital and financial account deficit. Remember, it is a simply an accounting reality. If you run a trade surplus, you must run a capital and financial account deficit. You must be a creditor to the rest of the world. Well, Japan has been. In blue, we can see uh their foreign exchange reserves. Now think of this uh as the country’s national savings right if you are uh exporting more value than you are importing well you are accumulating savings you’re accumulating wealth or assets these in blue are those assets mainly uh uh US treasuries about 1.1 trillion of this 1.2 two trillion is in US treasuries. Now remember, if you’re in Japan, if you’re the Bank of Japan and you own a two-year US Treasury, you own a dollar. You own an interestbearing dollar, you are long on the dollar. So, as we get into the yen carry trade here, remember that point. So, here we’re looking at the Japanese government bond market and of course in pink is zero. So, what we can see is that for years they had negative interest rates. What that meant is that money, the yen, uh, in particular, was free. Literally, the cost of money was negative, meaning that everyone was incentivized to go out and borrow in yen. But the problem was that the yen was uh weakening quite significantly. So, here we’re going to look at the yen dollar. This is not normally how it’s displayed, but I think it’s more intuitive to look at it this way. And we can see that the yen weakened pretty substantially. So what that meant is if you were borrowing in yen at negative interest rates or maybe zero uh you were incentivized to sell the yen putting more downward pressure on the yen and buy a stronger currency. In this case the dollar in the yen carry trade example it was the dollar. people would borrow in yen, sell the yen immediately, buy dollars, and then you get positive carry if you want to go use those dollars to buy US treasuries or uh uh stocks to some degree in real estate as well. So, this was a huge driver of liquidity globally speaking. There was basically a money printing machine called the yen carry trade. And it’s important to point out a lot of that yen carry trade at least the last time it unwound in uh summer of last year it came out reporting uh that a lot of that trade the yen carry trade where people were uh shorting the yen selling the yen to buy the dollar to buy US assets uh a lot of that was currency unhedged meaning that if the yen started to strengthen uh they were in big trouble now here we’re looking at interest rate differential relative to the strength of dollar yen and what we can see is going back to April. Uh the US uh 2-year government bond yield uh relative to the Japanese 2-year uh has actually contracted. So the relative premium or attractiveness of the yen carry trade has weakened. We can see that with the white line going from about 3.3% premium to buy US government bond uh than a Japanese one down to just 2.5% and falling. Uh despite that however, what has happened with the currency? Well, the dollar has strengthened and the yen has weakened. Remember the two two ways of saying the same thing in this case. Here we’re looking at the 10-year interest rate differential uh between Japan and the US. And again, the same story is true, which is the relative attractiveness of US government bonds is falling, meaning the attractiveness of that yen carry trade is falling. Now, yeah, the dollar has strengthened relative to the yen. So, you’re still picking up uh positive carry. And at this point, you still get 2.2% more interest, more yield uh on the US 10-year government bond than you do the 10-year government bond. But that uh spread is narrowing that interest rate differential is narrowing, making the attractiveness of that very large uh liquidity driver, the yen carry trade, less attractive. Now, getting to their stock market. So, here we’re looking at the nic225. Uh you can think of this as the S&P 500 for Japan and then in blue we’re looking at dollar yen exchange rate. Now because Japan runs such a large current account surplus uh they are an exportdriven economy uh you want actually a weaker currency because a strong currency actually means uh that your exports become less competitive on the global stage. This is the problem uh the US has run into. We have a vastly fundamentally overvalued currency. Therefore, we must run a trade deficit because our goods are not competitive on the world on the world stage. We have too strong of a currency. While in Japan, they want a weak currency. And we can see uh maybe not as strong of a correlation as with the interest rate differential here, but we do see a pretty modest uh correlation which is as the dollar strengthens or the yen weakness uh weakens, we can see strength in their stock market. However, what we are seeing recently is that their stock market has caught pretty significant bid year-to- date by the way. uh but recently we have seen that their stock market has rallied uh pretty significantly despite the fact uh that the dollar has weakened. Put another way the yen has strengthened. Now we’re going to look at fundamentals. So here is a growth differential and then the threearter rate of change of dollar yen. Uh yeah there’s some uh driver here fundamentals right if the US is experiencing stronger growth uh yes you might expect stronger US dollar. However, uh the correlation here is not as strong. I would point to the interest rate differential, which again, the 10-year is going to be driven much more by growth and inflation, nominal growth expectations. Uh so I would point to uh the 10-year interest rate differential rather than a GDP differential, growth differential in that way. Here we’re looking at the US bond market and what do we see for the past couple days? bond yields or past week or two, bond yields have been moving sharply higher, especially at the long end of the yield curve in the 30-year government bond here. Now, remember, as the bond yield is moving higher, the value or the price of the bond is moving lower in this case to the lowest level going back to September. Now, why is this happening? Well, again, remember that yen carry trade uh relies on US government bonds uh being more attractive than Japanese government bonds. Japan is the one that runs a very large current account surplus and that is a creditor. More value is acrewing to them and therefore they must put that value into foreign markets. Well, the attractiveness of US government bonds is declining. Now we have seen a dollar strengthening but the other problem here is that the the yen weakening right now at about 156. Uh the bank of Japan has come out the ministry of finance has come out and said that look we cannot tolerate too weak of a yen because it results in too much inflation. Uh therefore we will intervene. We’re not going to tell you exactly where, but we will sell those US dollar assets, those US treasuries, and then sell the dollar to buy the yen to artificially strengthen our currency if it starts to get too weak. Well, of course, they own $1.1 trillion of US treasuries. Uh that could cause some pretty significant uh problems in the US bond market. But not only that, the capital repatriation event. So what is that? That is where Japanese firms, individuals, banks uh might go, you know what, we put our money in US government bonds because our government bonds uh gave us basically no interest rate uh for many many years. So we had to go elsewhere like the US. But now we are starting to get interest rates uh that are somewhat appealing here in Japan. So we are going to sell the US treasury or if they bought US tech stocks for example sell the tech stocks to then sell the dollar cuz right these are dollar denominated assets so then they would have dollars well you don’t want dollars you want to buy a Japanese asset denominated in yen so you sell the US treasury then sell the dollar to buy the yen to then buy the government bond which would bring the yield lower we are not seeing a stabilization in Japanese government bond yields yet but That is what a capital repatriation event uh could do. And again remember trillions over many years if not decades going back to the 1980s. Trillions has been stashed in US dollar denominated assets. Now to take a look at the yield curve. I think that there’s something notable going on here. Down below we can see the 10-year minus Fed funds. Uh that particular spread is at the highest level going all the way back to January. And of course we have seen a general steepening of the yield curve especially after Kevin Hasset uh kind of a stoogge of the administration was floated as uh the next Fed share. We have seen a bare steepening of the yield curve as investors price in that fiscal dominance and that uh uh uh basically emerging market-like phenomenon of making the Fed a political organization making the central bank a political organization. generally uh we know that they’re headed towards negative real yields where uh government bond yields will be below the inflation rate. Well, that is very good for gold as we went into in our prior video about QE and how it is coming back and the effect that it’ll have on market. So, anyways, hopefully that was helpful. A couple risks to be aware of uh maybe to help explain some of the the the recent moves we have seen in the US bond market. However, again, there are also drivers here in the US uh like Kevin Hasset being named as a potential Fed share uh and of course the Bank of Japan, it should be noted uh has a interest rate uh decision coming up where they are going to decide whether or not to hike interest rates. Well, if they come out and hike interest rates, again, only at half of 1% right now. If they come out and hike interest rates, that could cause a rapid strengthening of the yen, which of course could unwind the multi- trillion dollar large yen carry trade. So, a lot of dynamics to be aware of. Hopefully that was helpful and I’ll catch you in the next

US Government Bond Yields are Soaring

There’s a Big Problem, and it’s coming out of Japan where their bond market continues to absolutely melt down, risking not only trillions of capital unwinding in the Yen Carry Trade, but a capital repatriation even causing trillions in US Stock and Bond sales

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Yen Carry Trade Unwind Explained, Capital Repatriation, Dollar, yen, bank of Japan, BoJ

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