Will BOJ-Fueled Treasury Selloff Continue Amid US Recession?

Treasuries experienced a decline for three consecutive days on Tuesday, following an unexpected change in policy by the Bank of Japan. This has sparked a discussion about whether the recent rise in bond markets has come to an end or if it is only temporary.

Amidst the uncertainty of a potential US recession, inflation, and Federal Reserve policy, investors may continue to show interest in US Treasuries. Although yields have risen in the past few days, 10-year Treasury rates are still lower than their 2022 peak by three-quarters of a point.

Tom Graff, the head of investments at Facet Wealth, a Baltimore-based firm that manages $1.5 billion of client money, believes that the peak of Treasury yields has already been reached for this cycle. He believes that a recession is very likely, or at least a slowdown, and it would be unusual to see the 10-year yields rise in the face of a recession.

The US 10-year yield rose sharply on Tuesday, reaching 3.71% by late morning in New York. This was an increase of 12 basis points from the previous day. The surge followed a similar jump in the Japanese government bond market, where the 10-year rate rose to around 0.40%.

Investors have been speculating for some time if the Bank of Japan (BOJ) will eventually move away from its long-term policy of ultra-low rates, which would be the last major central bank to do so. This could potentially remove a major support from global bond markets, and could accelerate the lift-off that has been driven by the Federal Reserve, the European Central Bank, and other central banks.

The Bank of Japan's (BOJ) recent action is not a complete departure from its near-zero policy, but rather a modification to its yield-curve control system that allows bond rates to increase slightly. The primary policy benchmark is still set at -0.1%, and the range of fluctuation for the 10-year yield is larger, yet the goal is to keep it near zero. Some view this as a sign of the beginning of the unwinding process, so the response of the markets is noteworthy.

Greg Peters of PGIM believes that the Bank of Japan has done an excellent job in their actions. He noted that the Japanese Government Bond reaction and the movement of the yen were both handled skillfully. Additionally, he pointed out that the correlation to US Treasuries was kept to a minimum, which makes sense.

Haruhiko Kuroda, Governor of the Bank of Japan, has taken a step that could potentially lead to more capital staying or returning to Japan. This would reduce the demand for US securities, as Japan is one of the largest holders of US Treasuries. This is evidenced by the surge in the value of the yen following the BOJ's announcement. All other factors being equal, this could have a significant impact.

From the viewpoint of Treasuries, Japanese investors have been net sellers for a majority of the year, even though the market has been on the rise. This is due to the high hedging costs, which are mainly caused by the rate differences between central banks.

The overall sentiment in the Treasury market has changed and there are a number of factors that could help bonds counter the bearishness from Japan. It appears that the Federal Reserve's hawkishness may have reached its peak. With the potential for a US recession in the near future, there is likely to be an increase in demand for safe havens. Additionally, central bank reserve selling, which had been a major factor in the decline of Treasuries, is decreasing as the cost of commodities decreases, taking the pressure off of countries like Japan.

In addition, there are indications that Treasuries are still overvalued in comparison to past trends, and that investors are still shorting them, which could lead to more buying. It is yet to be determined how the alterations in Japan will affect this.

Brian Svendahl, a senior portfolio manager of BlueBay US fixed income at RBC Global Asset Management in Minneapolis, believes that the move is likely to reduce the demand for Treasuries and other US debt in the long run, rather than causing a short-term shock.