Rates Spark: The yen link to US Treasuries

Recent developments hint at a connection between the yen's pressure and movements in US Treasury markets. The recent Japanese yen intervention saga appears to have created a significant stimulus flowing into interest rate markets. Our analysis suggests that prior weakness in the yen may be linked to the Bank of Japan's overly cautious stance and a policy rate that remains too low.

This is supported by our calculations, which indicate that the Bank of Japan's current policy rate is approximately 50 basis points below its neutral level when measured against the Federal Reserve's interest rate buffer. This financial tension is reflected in a notably weak yen and elevated long-term Japanese government bond yields, reaching into the 4% range for the 30-year yield.

Addressing this tension could potentially come through rate hikes, but this move may have both negative consequences for the economy and represent a strategic choice. Weighing these options, one must consider whether to prioritize protecting the yen or not. Concurrently, recent intervention between Japan and the US to strengthen the yen suggests a possible behind-the-scenes influence from US Treasury Secretary Brett.

It's plausible that he signaled his belief in Bank of Japan's policy tightening as a means of supporting the intervention. Additionally, the Treasury Secretary's decision to sell euros to buy yen is unusual, as sellers typically opt to sell US dollars rather than euros. While no explicit rationale has been provided, it's conceivable that the Secretary may have preferred to avoid a trade that would involve selling US Treasuries, either through the intervention or in the broader market. This speculation can't be confirmed, but it's a possibility worth noting.

Looking ahead, it's crucial to monitor these circumstances as the yen appears set to challenge its 160 US dollar level again. Given that the prior tension has not vanished, another test might face official resistance. It's essential to monitor the potential negative feedback loop into US Treasuries should further intervention occur.

If the US Treasury were to sell euros once more, there's a possibility that the European Central Bank could balance the trade by selling US dollars, which would then impact US Treasuries as well. This impact could potentially spread across the yield curve. Furthermore, the July US fiscal numbers were not promising, and they independently contribute to pressure on Treasuries.

Simultaneously, the gradual increase in longer-dated real yields since February is expected to persist, creating a persistent theme of negative pressure.

On the more positive side, recent US inflation data has reduced the likelihood of higher US rates in the near future. This development does not negate the possibility of a Bank of Japan hike, which could further support a US rate hike. While we are still a month away from a potential Fed decision, it's important to consider this positive development.