The Market’s Next Selloff May Start in the Land of the Rising Sun

We noted in this morning’s Swan Dive that 30-year U.S. bond yields are at 5% once again. Prior moves to this level have led to a sharp selloff over the past few years. This time may be different.

One reason? Deteriorating conditions in another key bond market – Japan. Best known for fighting deflation over the past few decades, Japan used to offer investors a near-zero yield – which in turn helped fuel “carry trades.”

This policy of borrowing in near-zero assets to buy higher yielding – and usually riskier ones – is a favorite among traders. Unless rates rise, since that compresses potential returns.

Today, Japan’s 30-year bond has soared to its highest yield in 25 years. And the country’s 40-year bond is at its highest yield since its inception, at 3.4%.

Remember last summer’s market selloff and soaring volatility index? It wasn’t just a tempest in a teapot. It was caused by fears that Japan would raise rates quickly, and compress the carry trade.

Today, Japan’s bond market is making that move even without its central bank. Just as how U.S. bond yields have jumped in the past year – despite the Fed cutting interest rates a full point.

Don’t be surprised if Japan’s rising yields spark another carry-trade unwind that roils the stock market. The good news? Unwinding leveraged trades takes dangerous leverage out of the global financial system.

-Addison