Thursday, June 9, 2011

Japan's Downgrade is Bearish For U.S. Treasuries

The recent rally in U.S. Treasuries has many of us wondering when the trend is going to end. One party disruptor may be Japan, a major foreign creditor holding some $900B of U.S. Treasury debt, second only to China, who holds ~ $1.15T. Japan may yet decide to liquidate some of its holdings to divert capital to post-tsunami rebuilding efforts or to invest in higher yielding debt or other investments elsewhere.

Japan's recent sovereign credit rating downgrades are perhaps warranted, but a tad nonsensical in comparison with a lack of an actual downgrade of U.S. sovereign credit. Though Japan's government debt/GDP approaches ~220% of GDP, the U.S. debt/GDP at ~100% of GDP is growing at a much faster rate and does not account for unfunded obligations that will easily exceed projected tax revenues.

The Yen carry trade that financed arbitrage-fancy T-bond purchases is not as lucrative as it once was, given the persistent strengthening of the Yen (USD/JPY is now trading again below 80). Given the U.S. debt profile, sitting on long-term U.S. debt has growing risks unless hedged. The Bank of Japan could see a sale of Treasuries and a purchase of higher yielding debt from other countries with stronger currencies as a prudent move as Treasuries continue to push higher on what I call a technical rally.

(Major foreign holders of Treasury securities are tracked by the Treasury here:

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