Treasury Yields Keep Rising. Japan Is One Big Reason.

When yields rise, it is a sign that someone, somewhere is selling bonds, given that yields rise when prices fall. Economists and strategists are pointing fingers at Japanese investors, who, with holdings totaling $1.1 trillion, are the top foreign owners of U.S. debt, surpassing China.

Japanese investors may be selling the U.S.
10-year
benchmark and buying their country’s counterpart as yields look increasingly inviting at home. Japan’s 10-year benchmark at 0.6614% settled at its highest level since 2014 on Tuesday. It is up 0.2145 percentage points since its low in July, the largest rolling 18-trading day increase since April, according to Dow Jones Market Data.

The rapid gains coincide with a historic shift in language by the
Bank of Japan,
which on July 28 allowed greater flexibility for the 10-year yield to rise as high as 1%, instead of limiting it to the prior range of plus or minus 0.5%. It was an adjustment to the bank’s policy of so-called yield-curve control, which involves keeping yields low by buying large quantities of Japanese government bonds when rates go above its allowable range.

Japan’s central bank opening the door has led to Japanese investors “looking at their own backyards” and reallocating their portfolios, Torsten Slok, the chief economist and partner at
Apollo Global Management,
told Barron’s.

At first glance, it might seem odd that Japanese investors may prefer 10-year Japanese debt yielding less than 1% over U.S. Treasury notes nearing 4.5%. The reason is that Japanese investors have yen to put to work, while Treasury notes are issued in dollars, and protection against losses from exchange-rate swings can be expensive.

“The cost of hedging out the dollar when a Japanese investor buys U.S. Treasuries offsets the benefit of a higher yield in the U.S.,” Peter Boockvar, chief investment officer at Bleakley Financial Group, told Barron’s via email. He said the Bank of Japan is a key contributor to the surge in U.S. yields.

While most developed countries have lifted interest rates from the lows seen during the Covid crisis, Japan has kept its short-term policy rate at minus 0.1%. The central bank’s relaxation of yield-curve control by allowing 10-year yields to rise above 0.5% not only gives Japanese investors more incentive to buy Japanese government debt, but has been seen as a signal that Japan’s role as the last anchor of low rates may not last.

That reinforces what investors already know: The era of easy money is more or less over globally, adding to the expectations of higher rates that are lifting yields in the U.S. Stronger U.S. economic data, which has made it seem likely that the Federal Reserve will keep rates higher for longer as it fights inflation, are playing a role as well. A third factor, among others, is that the U.S. Treasury has ramped up issuance of longer-dated debt.

Things may change in the bond market, but that wouldn’t necessarily be positive. Wolfe Research’s chief investment strategist Chris Senyek sees Japan adding another approximately 35 basis points, or hundredths of a percentage point, to global long rates over the near term. But “over the intermediate term, we expect the curve to reverse course and become more deeply inverted as recession fears start to hit,” he wrote in a note on Tuesday.

That means yields on longer-dated debt would fall further below those on short-dated securities. Yields on short-dated debt are normally below those on longer-dated borrowings. When that is reversed, as it has been for more than a year, it is generally seen as a signal that a recession is on the way.

Write to Karishma Vanjani at [email protected].