Last week, Japan and the U.S. Treasury Department took coordinated action—Japan sold euros and propped up the yen after it had fallen to record lows. But Japan’s currency weakness has deeper roots: Inflation is picking up, while the Bank of Japan (BOJ) is keeping its monetary policy far too loose. Yet Japan has little room to maneuver. Public debt stands at around 230 percent of GDP, and the BOJ holds about half of it. If the central bank were to raise interest rates significantly, it would incur enormous costs—but any delay in normalization further erodes confidence in the yen.
The real risk lies in the interest rate differential with the U.S. Higher Japanese yields would narrow the spread with U.S. yields and could trigger a massive unwinding of carry trades—a scenario that would weigh on risk assets and intensify selling pressure on U.S. Treasuries. That is why the BOJ is forced to sell U.S. Treasuries to defend the yen without raising its own interest rates. That was also the reason for Washington’s intervention: to limit these sales—at a time when the 30-year Treasury yield had risen to its highest level since 2007. However, the BOJ seems too complacent. The longer normalization is postponed, the greater the risk of a sudden, sharp adjustment.
The most likely outcome is precisely such a broad unwinding of carry trades. That would hit the U.S. bond market at a particularly fragile moment—yields are already elevated, the federal debt continues to grow, and government bond issuance and refinancing remain substantial, with a maturity structure heavily concentrated in the short-term segment after the market had positioned itself for interest rate cuts that had been expected prior to the Iran conflict. Additional selling pressure in such an environment could become massive and force the Federal Reserve into its customary role as buyer of last resort. Whether through Fed liquidity injections or a highly indebted BOJ fighting to preserve the yen’s credibility—the message is the same: The macro environment is becoming increasingly favorable for scarce stores of value such as $GOLD and $BTC (+0.25%).
