The Japanese bond market strengthens, shaking global asset allocation; U.S. bonds and U.S. stocks may enter a new round of adjustment

According to Zhitong Finance APP, recently, the yield on 30-year U.S. Treasury bonds has surged significantly, becoming the focus of investors' attention on the U.S. fiscal outlook. However, behind this phenomenon lies another increasingly critical variable that has been overlooked: the turmoil in the Japanese bond market.

A few days ago, the auction of Japan's 20-year government bonds was lukewarm, triggering the yield on 30-year U.S. Treasury bonds to soar to 3.165%, briefly approaching 3.17%, marking a new high in about 25 years. At the same time, the yield on 40-year government bonds also jumped to 3.672%, the highest level since this bond type was established in 2007.

Japanese financial institutions have traditionally been significant buyers of U.S. Treasury bonds, particularly supporting the global bond market through "yen financing arbitrage transactions." The core of this strategy is to borrow yen at low interest rates, convert the funds into high-yield currencies, and invest in bonds denominated in those currencies. However, this long-standing trading model now faces the risk of termination.

Albert Edwards, a strategist at Industrial Bank, pointed out that if high yields in Japan attract domestic funds back, the "unwinding" of this arbitrage trade could have a dramatic impact on the U.S. financial market. He vividly stated that this could trigger "a huge suction sound" in the U.S. Treasury and stock markets.

In a research report on Thursday, Edwards wrote: "Many commentators currently attribute the rise of the 30-year U.S. Treasury yield to 5% to domestic fiscal factors, overlooking the context of global market interconnections. U.S. Treasuries, the U.S. stock market, and even the dollar itself have historically been driven by capital flows from Japan." He further emphasized: "For investors, understanding and tracking the surge in Japan's long-term bond market is the most important thing right now."

His remarks suggest that the selling frenzy in the Japanese bond market may have already directly impacted the U.S. long bond market. On Thursday morning, the yield on 30-year U.S. Treasury bonds briefly rose to 5.15%, the highest intraday level since 2007, reflecting that investors are aggressively selling such long-term bonds. Subsequently, U.S. Treasuries rebounded, with yields dropping by 2.6 basis points to 5.063% during the afternoon trading session in New York.

Meanwhile, U.S. stocks showed volatility, with the Dow Jones Industrial Average and the S&P 500 slightly declining, while the Nasdaq Composite Index rose by 0.28%.

The early morning turbulence in the U.S. bond market is largely believed to be related to the massive tax cuts and spending proposals pushed by the Republican Party, proposed by former President Trump. This bill has intensified market concerns about the U.S. fiscal outlook, leading to a decline in investors' willingness to continue purchasing U.S. Treasury bonds.

George Saravelos, a researcher at Deutsche Bank in Frankfurt, further pointed out that one of the most representative signals of increasing U.S. fiscal risk is the "decoupling" phenomenon between U.S. Treasury yields and the yen exchange rate. He noted that despite rising U.S. Treasury yields, the yen continues to appreciate, which may indicate that foreign investors are gradually exiting the U.S. Treasury bond market

Saravelos also stated that some market participants view the surge in Japanese government bond yields as a concern for Japan's fiscal situation, but he believes it is more likely a threat to the U.S. Treasury market. He said, "The sell-off of JGBs (Japanese Government Bonds) makes domestic Japanese assets more attractive to investors, which will further accelerate their withdrawal from the U.S. market."