Toru Hanai | Bloomberg | Getty Images Japan’s bond market is igniting fears of capital flight from the U.S. and a carry trade unwind as long-dated yields hover near record highs.
Higher yields and stronger yen will impact domestic appetite to invest abroad, he told CNBC.
The carry trade unwinding that is about to ensue will be worse than that in August, warned Alicia García-Herrero, chief economist for Asia Pacific at Natixis.
Gradual unwind Other analysts say the carry trade impact may not be as severe as witnessed last year.
Additionally, foreign holdings of U.S. assets are concentrated in U.S. equities, rather than Treasurys, data provided by State Street showed.
Bloomberg | Getty Images | Toru Hanai.
Fears of capital flight from the United States are being stoked by Japan’s bond market. S. As long-dated yields linger close to record highs, a carry trade unwinds.
As the demand for 40-year government bonds reportedly fell to its lowest level since July of last year, according to Reuters’ calculations, yields resumed their upward trend on Wednesday, remaining close to record highs set last week.
The yields on Japan’s 40-year government bonds reached an all-time high of 3point 689 percent on Thursday and were last trading at 3point 318 percent, which is nearly 70 basis points higher than they have been this year. In contrast to yields on 20-year government debt, which are up more than 50 basis points this year, 30-year government debt yields are up more than 60 basis points this year at 2.914 percent, which is also not too far from all-time highs.
Japan appears to be a ticking time bomb. Confidence in the global market may suffer if trust in one of the historically secure assets of the financial sector collapses.
Gayed Michael.
manager of the Tidal Financial Group’s portfolio.
Increased yields on Japanese government bonds may cause a capital repatriation wave, with Japanese investors withdrawing money from the United States. S. There may be a “trigger point” at which Japanese investors abruptly withdraw their funds from the United States. A. In a note, Macquarie’s analysts stated, “Back home.”.
The move could “trigger a global financial market Armageddon,” according to Albert Edwards, global strategist at Societe Generale Corporate and Investment Banking, if Japanese government bond yields keep rising.
He told CNBC that the domestic desire to invest overseas will be impacted by higher yields and a stronger yen. Funding the U.S. S. . was looking for higher interest rate returns and as much currency gains. Edwards called U out. S. . Tech stocks, which have experienced significant Japanese inflows, are especially vulnerable to a stronger yen.
According to Quantum Strategy strategist David Roche, elevated yields are a sign of trouble for global markets as a whole because they result in higher borrowing costs. The stakes are raised further by the fact that Japan is the second-largest creditor in the world. In 2024, the nation’s net external assets reached a record-breaking 533.05 trillion yen ($3.7 trillion).
“Reducing global liquidity will limit global growth to 1 percent, and raising long-term rates will tighten financial conditions and prolong the bear market in the majority of assets,” he stated.
This money repatriation to Japan is regarded as the “end of U.S. A. “and is reflected elsewhere in Europe & China,” Roche continued.
Have trade jitters.
A major structural factor contributing to the steepening of Japan’s yield curve is that Japanese life insurance companies, which are a major source of demand for 30- and 40-year JGBs, have largely satisfied their regulation-driven buying requirements, according to Rong Ren Goh, portfolio manager in the fixed income team at Eastspring Investments.
Because private players have not stepped up and the Bank of Japan has reduced bond purchases in a landmark monetary policy change last year, the demand-supply mismatch is likely to drive higher yields.
“If Japanese investors are drawn back home by noticeably higher JGB yields, the unwinding of the carry trade may result in a loud sucking sound in the U.S. S. monetary assets,” Edwards remarked. In general, higher yields make the currency stronger.
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Carry trades are borrowing money in a currency with a low interest rate, such as the Japanese yen, and then using that money to invest overseas in assets with higher yields.
When the Bank of Japan raised interest rates in August of last year, the Japanese currency strengthened and a major sell-off occurred in international markets, causing yen-based trades to abruptly unwind.
It appears that Japan is a ticking time bomb. Michael Gayed, author of the Lead-Lag Report and portfolio manager at Tidal Financial Group, stated that people tend to believe that what happened in August was a “one-time” incident. “If confidence in one of the financial market’s traditionally safe assets has cratered, confidence in the global market could go with it,” he added.
According to Gayed, one of the present U. A. In order to address global trade imbalances, the administration’s main objectives are to weaken the dollar and reduce bond yields. If this occurs concurrently with rising Japanese bond yields, it undermines the cheap yen narrative that initially drives the yen carry trade.
“You’re looking at a potential repeat of last August,” he said, adding that it might cause many traders to unwind their short yen positions.
The upcoming unwinding of the carry trade will be worse than the one in August, cautioned Alicia García-Herrero, Natixis’ chief economist for Asia Pacific.
The yen’s strengthening, which is partly due to investors reducing their exposure to the US dollar and capital going home, is unsustainable for Japan’s economy, she continued.
Since the year began, the yen has appreciated by more than 8%.
Calm down a bit.
The impact of the carry trade might not be as bad as it was last year, according to other analysts.
“When there is a significant short-term interest rate differential and a strong foreign exchange trend or very low FX volatility, big carry positions tend to accumulate,” stated Guy Stear, head of developed markets research at Amundi.
Second quarter 2024: The difference between the U.S. S. According to data from Amundi, the yield on the 2-year Treasury and its Japanese counterpart was 450 basis points, as opposed to the current 320 basis points.
According to him, the benefit of shorting the yen is “less apparent,” and fewer short yen positions exist now than there were the previous year due to the dollar’s decline.
Although August was “a crater in one go,” the carry trade unwind is probably going to experience a gradual decline this time due to the deterioration in confidence on U. S. . dollar,” stated Riccardo Rebonato, an EDHEC Business School finance professor.
He said to CNBC, “I see a progressive erosion over a long period of time, rather than an implosion.”.
Japan’s substantial U.S. S. . Treasury bonds are rooted in the larger U.S. S. According to Masahiko Loo, senior fixed income strategist at State Street Global Advisors, the Japan-Japan strategic alliance includes defense, economic, and geopolitical cooperation.
Loo stated, “There is therefore minimal risk of Japanese investors selling off or ‘dumping’ foreign bonds.”.
Furthermore, overseas holdings of U.S. S. Assets are mostly located in the U.S. A. equities, not Treasurys, according to State Street data.
A greater percentage of foreign U. S. . With nearly $18.5 trillion in equity holdings, asset holdings are concentrated in the U.S. A. Torsten Slok, Apollo’s chief economist, estimates that Treasurys are worth $7.2 trillion.
“We think it likely the outflow will come from equities first, with corporate bonds next, and unlikely to start with Treasurys,” Loo continued, “although we cannot rule out some degree of foreign capital outflows from risky assets in the event of a severe US recession or an intensified “sell America” narrative.”.
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