- Yen weakness and rising JGB yields are nolonger isolated domestic issues; they posebroader risks to global duration markets,especially long-dated USD bonds
- Japan’s high debt burden limits howaggressively the BOJ can tighten policy,leaving inflation expectations and long-endJGB yields vulnerable
- Japan’s creditor-nation status and large netinternational investment position gives itample foreign assets to defend the yen, butany capital repatriation could pressure USTreasuries via reduced Japanese demand
- We believe the US has intervened in the yento reduce risk of such capital flight. Thissuggests potential “lines in the sand” for USyields, but debt sustainability and inflationremain key headwinds; we prefer 5–7Y duration and A/BBB credit
Related insights
Chaos theory. Over the last few weeks, Japan and the United States launched a rare joint currency intervention—the first major coordinated G7 action since 2011—spending nearly USD59bn to prop up the JPY after the currency hit 40-year lows. While seemingly unrelated, we believe this has material implications for the fixed income landscape. Now in case one thinks that we are greatly exaggerating causality, a little scrutiny reveals that such coordinated currency interventions across the Pacific are in great part to do with both gargantuan UST and JGB bond markets becoming unsustainably large in the face of rising inflation. As such, a butterfly flapping its wings in the FX markets can set off a tornado in the bond markets; it was perhaps best that the US caught said butterfly before their own yield curves went out of control.
Land of the rising yields. It was more than three years ago that we addressed this risk that was quietly bubbling in the ramen broth in our CIO Perspectives (Land of the Rising Yields: Influence on Longer-dated USD Bonds, published 27 Jan 2023). Market observers would also note that JGBs have since done exactly as the title suggested, which hopefully lends credence to the thesis at the time. Back then, unlike the rest of the world, the Bank of Japan (BOJ) was running an extremely accommodative monetary policy (negative yields). Our take was that onshore yields in Japan would continue to rise as the BOJ removes accommodation in the face of sticky inflation, causing a risk to long duration bonds across the developed market bond universe due to the permeability of capital flows. Seeing as 30Y US treasuries have since risen from c.3.62% at the time of reporting to c.5.25% today (with JGBs faring even worse), it would have benefitted fixed income portfolios to have heeded that risk.
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