JAPAN TRIGGERS A DOLLAR CRISIS / MACLEOD FINANCE

Japan triggers a dollar crisis 

The Japanese government’s reflation plans are driving JGB yields significantly higher, likely disrupting US Treasury financing, and bursting the equity bubble.

ALASDAIR MACLEOD

Both the chart above and risk analysis assessments point to far higher US bond yields after the current pause completes. 

Put another way, something has to scare off foreign and domestic institutions from buying US treaty debt. 

The Japanese government is creating such a scare.

The new Prime Minister, Sanae Takaichi, is set on cutting taxes without reducing spending. 

It looks like a Liz Truss rerun, which drove UK gilt yields higher creating a liability-dependent investment crisis, and requiring the Bank of England’s intervention. 

Truss was forced to resign, but Sanae Takaichi is forestalling her defenestration by calling a snap election.

Her bet is that the electorate will favour tax cuts. 

Consequently, JGB bond yields are soaring and will continue to do so, with the 10-year JGB yield currently at 2.295%.

The problem for Japanese institutions is that the yield differential between JGBs and US Treasuries is closing rapidly, leaving diminished returns to compensate for currency risk. 

For US hedge funds, the yield differential on the yen-based carry trade becomes threatened, if as seems increasingly likely the Bank of Japan has to raise its short-term rates further. 

Consequently, government bond yields around the world are rising, with some such as Germany’s already breaking higher.

The risk for everyone is that the much predicted funding crisis for US Treasuries is next. 

The only foreign buyers of US treasuries are tame US trolls. 

Shortly, not even the carry trade enjoyed by Cayman Island US funds will work, and funds funnelled through London and Luxembourg will grind to a halt. 

For doubting Tomases, think through the implications of Japan’s Liz Truss.

Then there’s the problem of bubble valuations in equities, which have become totally unhinged from bond markets.

Forget brokers’ blandishments on the buying tack. 

This valuation extreme for the S&P is at record bubble levels, almost certainly surpassing late-1929 which led to the biggest market crash Wall Street had ever seen.

Now ask yourself how foreigners, let alone US institutions asleep at the wheel will react. 

Foreign investors have over $40 trillion invested in dollars and underlying financial instruments. 

And that’s only onshore. 

Add in a president running the White House as a branch of diplomatic bedlam, and you have the makings of a very nasty, sudden market crisis.

I note that gold is up over $170 in Asian markets overnight at $4865, confirming fears for the dollar’s future. 

Given the dynamics of the current situation outlined above, this appears to be the start of an acceleration phase in the dollar’s decline.