This is "the best market indicator for measuring U.S. fiscal risk"

Deutsche Bank warns that the fiscal risks in the United States are accelerating, and the growing divergence between U.S. Treasury yields and the USD/JPY exchange rate has become the most important market indicator.

Recently, George Saravelos, the head of foreign exchange research at Deutsche Bank, analyzed that despite rising U.S. yields, the yen is unusually strengthening, which is clear evidence of reduced foreign participation in the U.S. Treasury market and has become the most important market indicator of accelerating U.S. fiscal risks.

Although Japan's long-term yields have risen strongly in recent days, some interpret this as a signal of worsening fiscal issues in Japan. However, Deutsche Bank believes that if Japan indeed faces fiscal concerns, the yen should weaken rather than strengthen. According to the global macro framework released by Deutsche Bank last week, given that Japan has a positive net foreign asset position, its fiscal space remains ample.

More critically, Deutsche Bank believes that the sell-off of Japanese government bonds poses a greater problem for the U.S. Treasury market: by making Japanese assets an attractive alternative for local investors, this further encourages divestment from U.S. assets.

Dollar Depreciation: The Only Way Out of America's Twin Deficits

After a weak Treasury auction this Wednesday, Saravelos pointed out that various asset participants in the market reacted "very negatively." In his view, it is difficult for the U.S. stock market to maintain resilience in such an environment:

In such an environment, it is difficult for the U.S. stock market to remain resilient. The period from 2023 to 2024 saw U.S. yields and stock markets rise in sync because the market adjusted its expectations for U.S. economic growth, which was entirely reasonable at the time. But the situation is now completely different. It is hard to say that the negative factors of rising capital costs will have a positive impact on risk assets.

Saravelos further pointed out that the most concerning aspect of the market reaction triggered by the bond auction is the simultaneous weakening of the dollar:

This is a clear signal that foreign buyers are resisting U.S. assets, while also reflecting the U.S. fiscal risk issues we have long warned about. The crux of the problem is that foreign investors are no longer willing to fund America's twin deficits (fiscal and trade deficits) at current price levels.

Regarding how to resolve the current predicament, Saravelos's conclusion is simple and clear: "'Solving' this problem is not easy... only Congress can solve it, not the Federal Reserve." In his view, dollar depreciation will be the ultimate release valve for America's twin deficit issues