As the Japanese bond goes, so goes the U.S. Treasury.
That’s the playbook Treasury Secretary Scott Bessent is playing from. For U.S. investors, Japan is no longer a distant curiosity with a quaint currency problem and an aging population.
It is the first major sovereign bond market showing what happens when a heavily indebted government meets rising yields after decades of cheap money.
After Federal Reserve Chairman Kevin Warsh’s Friday address in front of the Jackson Hole symposium, the Japanese yen fell back toward the same 40-year lows Bessent had been trying to defend against in late July.
Today, you can again buy ¥160 with every U.S. dollar. And even as U.S. yields continue to rise, Japan’s 10-year yield just topped 3% for the first time since 1996:
Japan’s 10-year yield has topped 3% for the first time since 1996. (Source: Jim Bianco)
For decades, Japan exported cheap capital to the world. Investors borrowed in yen, paid next to nothing for the privilege and bought higher-yielding assets elsewhere. That was the carry trade. It helped support global liquidity, U.S. Treasurys and risk assets.
Now, the math is changing.
If Japanese yields rise, Japanese capital has more reason to come home. If the yen keeps falling, Japan has more reason to defend its currency.
And if Japan defends the yen by selling U.S. Treasurys, American bond prices fall, and American yields rise.
That is how Japan’s problem becomes America’s problem.
Bessent recognizes the chain reaction. His late-July “yentervention” was not charity for Tokyo. It was an attempt to keep Japan from dumping Treasurys into an already fragile U.S. bond market.
His Treasury Twist — buying back longer-dated U.S. bonds while leaning more heavily on short-term bills — is another attempt to keep long-term yields from running away.
So far, the bond market has not been especially impressed.
U.S. yields remain stubbornly high. Japan’s yields continue pressing into territory not seen in a generation. The yen remains weak. The carry trade has not blown up yet, but the pressure points are visible.
Meanwhile, the Fed has stepped back. As he made explicit on Friday, Warsh says the central bank will no longer play the old role of market nursemaid.
At Jackson Hole, he even found a way to work the word “hike” into his remarks while talking about mountain trails. Markets took notice, dropping roughly 2% across the three major indexes.
That leaves Bessent in an awkward position. He is trying to support the yen, calm the Treasury market, execute a Treasury Twist, pressure the Fed to cut short-term rates by 50 basis points and manage Operation Economic Outcast against Iran — one of the largest financial warfare campaigns ever conducted through the dollar system.
The risk is not that any one of these pieces breaks the system on its own. The risk is that they all connect.
Japan’s bond market pressures the yen. The yen pressures Treasurys. Treasurys pressure U.S. borrowing costs. Higher borrowing costs pressure the federal deficit. The deficit pressures the Fed. The Fed’s choices pressure the dollar. The dollar pressures gold, silver and bitcoin.
For now, with global stock markets near all-time highs, the price action signals that the real danger of a yen carry trade blowup isn’t here yet.
Today’s Grey Swan Pro recommendation is “counterintuitive,” as Andrew Packer explains, but takes into account what actually happens when interest rates soar as opposed to how they should, theoretically.
~ Addison
P.S. This week on Grey Swan Live!, we’re bringing back Jeff Opdyke.
A former Wall Street Journal writer, Jeff has been living and investing internationally for two decades. Jeff currently pens the Global Intelligence Letter from his home in Portugal.
Jeff has already joined our mission to create a global fraternity of thinkers, philosophers, and investors. On Thursday, he’ll share his unique view on America’s decline from abroad, providing critical insight ahead of the midterms.
If Japan is the canary in the coal mine for the bond market, America may be the canary in the coal mine for the political order. The midterms are approaching. The debt burden is rising. The old assumptions about U.S. exceptionalism are being tested in real time.
A program note: We will also be speaking at Jeff’s Summit in Dublin in October. The theme: how Americans can think, invest and live with more freedom when the old home-country assumptions begin to fail. More details to come.
Join us on Thursday as we chat with Jeff on Grey Swan Live!
