Japan’s Bond Meltdown Sends Yields Soaring- Multi-Trillion Carry Trade & Capital Repatriation Risks

Japan’s Bond Meltdown Sends Yields Soaring- Multi-Trillion Carry Trade & Capital Repatriation Risks

Japanese bonds meltdown as their currency plummets. Despite hiking interest rates to the highest level in over 30 years overnight, the Japanese yen continues to absolutely plummet alongside their government bonds. What’s in store for the yen carry trade? And are there even bigger risks? So overnight, the Bank of Japan did hike interest rates to the highest level in 30 years, and there are shock waves being sent through the global currency markets and global sovereign debt as well. So, Bank of Japan did not only hike interest rates uh by 25 basis points now to 3/4 of 1%. But they also signal that more rate hikes are actually on the table. But despite that, the pink line shows uh the Bank of Japan decision. Despite that, we can see the yen verse the dollar. Probably the most intuitive way to think about it. The yen weakened quite substantially and is plumbing new lows there. uh dollar yen right now at about 157 and a half. Now here’s why it matters and here’s why it could have uh huge implications for the US for the US Treasury market and of course US interest rates. So Japan runs a very large current account surplus. This is one of the two main accounts to always examine with a country. Uh this is mainly the bounce of trade or the trade balance uh for Japan. They run a very large trade surplus. So the value of their exports is greater than the value of their imports. However, despite that, they do run a fiscal deficit. Now, Takaichi, the uh populist prime minister that was just elected and leading to some of the yen weakness that we have seen recently, very very dovish prime minister when it comes to monetary and fiscal policy. She wants to run an even larger fiscal deficit and she wants the Bank of Japan to run very dovish monetary policy. So this is part of why the yen started to weaken is due to that populism. Populism is very inflationary and of course in Japan we know uh longtime viewers of the channel that their inflation rate uh is significantly higher than the rest of the world. So uh here’s a chart from Jim Biano by the way showing that the Bank of Japan is expected to aggressively hike in 2026. But again, it’s important to point out that inflation rate 3%. Japan’s inflation rate is already at 3%. And look what started to happen back in 2021. This is when uh their yield started to rise as inflation started to take off in Japan. We could see the 10-year and the 30-year start to climb higher. Of course, that has accelerated recently. And of course, also, it is important to always point out that the bond price is inverse to the yield. So as yields are climbing, the other way of saying that is that the bond’s price is headed lower. Now by the way, this is what blew up multiple regional banks. Three of the four largest bank failures in US history happened in the past four years. Uh this is what happened. Those US regional banks bought a lot of long-term, you know, 10, 20, 30-year government bonds at very very low interest rates. And then what happened? Interest rates started to uh uh sore. And so what happened to the bond value or the bond price? It started to dump and so that is what led to the insolveny. Of course there was a bank run that uh uh really really spurred the the regional bank failures. Uh but that is why they were not able to come up with the cash is they had been expecting oh we’ll just buy some 10 years some 20 years some 30-year government bonds and if we ever need to we can always sell them. The problem was when they needed to uh the bonds were worth significantly less here in the US about 45% less for something like TLT. Now it’s also important to point out that Japan has had a breakout when it comes to wage growth. Remember they had the last decades uh this is very poor even negative wage growth uh for for many years and that is what led to of course very low interest rates. We can see the dotted pink line represents zero. We can see they actually had negative interest rates. So that overnight uh bank of Japan interest rate was negative. And not only that, but they had yield curve control which artificially suppressed bond yields. And we can see see that here uh the one-year, the 2-year, the 5year, even the 10-year had negative rates, meaning of course uh that money was free. And so what everyone did is they went out and they borrowed yen because there was no cost to do so. The price of the yen, the interest rate was zero or even negative. Uh meaning this was the whole point of having negative interest rates. You spur economic activity. Well, the problem is that what it actually spurred uh to some degree it did spur economic activity, but what it really spurred was the yen carry trade where uh folks would go and borrow in yen because it was free or even uh you were paid to do so. basically negative interest rates uh borrowing yen but then they didn’t want to hold the yen because remember the yen was uh weakening here we can see yen dollar uh the yen was weakening so they didn’t want to hold the yen what they would do is sell the yen putting more downward pressure to buy the dollar uh so that put upward pressure on dollar yen or downward pressure on yen dollar uh weaken the yen and then with those dollars uh global capital would go and buy US treasuries or they would buy tech stocks uh Well, as the yen carry trade uh starts to unwind in a way uh because again as we can see the the yen is no longer free anymore. We can see the 30-year for example up at 342 and the 10-year breaking that uh 2% level that a lot of people have been watching. Uh this is uh kind of an end to the yen carry trade because now uh that yen is not free anymore. So is the removal of a liquidity driver not a primary liquidity driver but around the margin the yen carry trade up to 78 trillion dollars large. So very very important as a marginal driver of liquidity that is no longer there for US treasuries and uh for of course US tech stocks as well. uh this could be the removal of uh you know one of those marginal liquidity drivers that has helped uh buoy of course uh momentum stocks here in the US as well as US treasury prices. Now uh Bank of Japan also announced I thought this was interesting about 330 billion uh yen excuse me per year in ETF holdings. Now the the Bank of Japan uh holds an an enormous amount as you can see there an enormous amount of Japanese stocks and I did want to point to that as one of the bright spots for Japan. So in blue we can see uh the Nicay 225 denominated in yen has had a very very strong year in fact has outperformed uh the S&P 500 uh for the year to date. We can see that in green. Now, generally speaking, as we can see, uh it is uh relatively uh flat versus something like the S&P 500. Both denominated in dollars, relatively flat over longer periods of time. But year-to date, uh the NIC is really performing quite strongly. Again, despite that yen weakness, because remember, if you are a current account surplus country, yen weakness, your currency weakening is actually really good. Uh yes, it might cause slightly higher inflation, but is really good in terms of booing uh your current account surplus. And remember, the other side of a current account surplus is that you must have capital and financial account outflows. This is why Japan is such a large holder of US Treasury debt and of course other assets, real estate being one of them. Here on the West Coast, Japanese investors own an enormous amount of real estate. Uh that is again just a balance of payments accounting reality that when you run a current account surplus you are a creditor to the rest of the world and when you run a current account deficit you are a debtor like the US to the rest of the world. Japan uh of course holds a tremendous amount of US treasury debt and US assets broadly speaking. Well what happens when their interest rates uh that are no longer negative anymore? What happens when their interest rates are finally appealing and a Japanese investor is able to finally get yield? Well, they might sell some of their US dollar denominated assets uh to bring that capital back home. Now, this is basically the opposite of kind of the yen carry trade. This would be selling of US treasuries putting downward pressure US treasury uh uh prices upward pressure on the yield. Then, of course, they don’t want dollars. They want to buy Japanese assets. So they have to sell the dollar to buy the yen uh to then buy JGBs to then buy uh maybe stocks. And so a rem a reversal of that flywheel that had been spinning for many many years uh could be again another uh pretty significant driver for something like uh interest rates here in the US and that’s what I want to point to here. So here we’re looking at interest rate differential between the US and Japan. uh as we can see the vast majority of the time I mean here in 2023 for example uh the US 10ear yield was 4% higher than the Japanese 10year JGB yield well that interest rate differential or the relative attractiveness of US treasuries relative to Japanese uh government bonds that relative attractiveness is fading and it’s fading pretty significantly now despite that you do have a strengthening of the dollar put another way you have a weakening of the yen despite the fact that interest rate differentials are narrowing meaning US treasuries are no longer nearly as appealing at 2.1% as they were back here for example at 4% or 3 and a.5%. So again capital repatriation and a reversal of the yen carry trade both of those could be pretty catastrophic uh for US Treasury yields. This is part of why Scott Essent was trying so hard, very unusually, to get the Bank of Japan to hike interest rates is uh to calm down the long end of the yield curve uh which hasn’t necessarily worked uh too well even despite the interest rate hike that we got overnight. Now inflation again running at about 3% their GDP real GDP uh this is a four uh uh period moving average to get a bit higher frequency data right now running at about 0.6%. If we look at differentials uh for both GDP growth and inflation, here they are. Uh we can see US GDP right now running about 1% higher uh than Japanese GDP and US inflation right now below Japanese inflation. So again, Japan is kind of an idiosyncratic story when it comes to global macro. Most central banks are hiking interest rates. Bank of Japan will be uh raising interest rates. Uh this could spell trouble. Of course, higher yields in one place lead to higher yields everywhere, and we can see that reflected here. So, the French 30-year is soaring to a record 30-year yield. Uh the British 30-year yield is up above 5%, well above 5%. Of course, we covered the Japanese 30-year uh GGB yield right now at 3.42. And of course, not only that, but US long-end rates have been rising recently. Uh so those holders of TLT not doing too well. uh this would give me a lot of anxiety if I was holding long bonds anywhere in the world. Now, not only that, but German 30-year bond yields are rising as well right now up to about 354. So, what is the effect on US interest rates and that yen carry trade and capital repatriation? Well, again, uh as interest rate differentials narrow, the attractiveness of Japanese capital of buying again, they run a very large current account surplus. So there is a huge amount of money that they have to invest. Uh it becomes less attractive to to put that into US treasuries. That is the removal around the margin of one of the largest buyers of US Treasury debt. Well again remember bond yield is inverse to the price. So if you have a removal of demand and again we know the supply of bonds is skyrocketing due to the enormous fiscal deficits here in the US. Well, if supply is increasing and you have one of the largest buyers uh potentially stepping away again because now finally for once in decades uh for the first time in decades you actually have an attractive yield in Japan and the relative attractiveness of US treasuries is reduced. Uh well that could spell trouble for US rates. You also have capital repatriation as a potential issue where again a lot of that capital that Japan uh whether it be a individual or a uh firm or even the central banks parks into US treasuries that could start to get sold and repatriated back home. Of course that could spell real trouble for US rates which again we know have climbed significantly uh from the tenure out uh since the Fed start to reduce interest rates. So, the Fed has taken the overnight interest rate from 5.3 all the way down to 3.6. And despite that, the 30-year yield has gone up. The 10-year yield has gone up. The 5-year yield has also gone up uh to a lesser extent. So, we are already kind of in a fiscal uh issue, spot of bother for the bond market. This uh in Japan could just make it even worse. Of course, we’re already seeing uh uh the long end of the yield curve all over the world already starting to have issues really for the past three or so years. Uh so definitely something to keep an eye on. Hopefully that was helpful and I will catch you on the next

Japanese Bonds Meltdown as their Currency Plummets

Despite hiking interest rates to the highest level in over 30yrs, the Japanese Yen continues to absolutely plummet alongside their government bonds. What’s in store for the Yen Carry Trade and are there even bigger risks?

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