The greatest risk to global portfolios from Japan’s currency crisis isn’t the yen, it’s the potential for disruption in the US Treasury market, warns the CEO of deVere Group, as the Japanese currency sinks to its weakest level against the dollar since 1986.
Nigel Green says that if Japanese authorities are forced into sustained intervention to defend the yen, they may have little choice but to liquidate substantial amounts of foreign reserves, including US government bonds, potentially creating fresh pressure in the world’s most important debt market.
“Everyone’s focused on whether Tokyo will intervene in the currency market as the yen hits its lowest level in four decades. The more important question is how Japan pays for that intervention,” he explains.
“If authorities are compelled to step up support for the yen over a prolonged period, global investors could suddenly find themselves confronting an entirely different risk: one of the world’s largest foreign holders of US Treasuries becoming a more significant seller.”
Japanese officials have repeatedly stated that they stand ready to take decisive action against excessive currency volatility, while Japan has already spent more than 11 trillion yen on intervention efforts during previous episodes of market stress.
Too many investors and analysts, says Nigel Green, who are concentrating solely on the foreign exchange implications of intervention, are overlooking what could become a far more consequential development for global financial markets.
“Japan’s currency weakness is widely viewed as a domestic issue which, I believe, is a mistake,” comments the deVere CEO.
“Japan remains one of the largest foreign holders of US government debt. If intervention efforts become larger, longer, and more frequent, the implications go well beyond the foreign exchange market.
“Japan holds more than $1 trillion in US Treasury securities, making it one of the largest overseas creditors of the United States.
“To support the yen, Japanese authorities must sell foreign currency reserves, which are heavily invested in dollar-denominated assets, including US government bonds.”
The deVere CEO argues that the fundamental challenge facing Japanese policymakers is that intervention alone is unlikely to reverse the structural forces driving yen weakness, including the wide interest-rate and yield differences that continue to favour dollar assets over Japanese assets.
“The uncomfortable reality for policymakers is that intervention can slow a market move, but, as history teaches us, it rarely changes the underlying economic fundamentals,” he affirms.
“As long as investors can borrow cheaply in yen and earn substantially higher returns elsewhere, the structural pressure on the currency remains in place.”
This, he says, creates the possibility of repeated interventions that gradually increase pressure on Japan’s foreign reserve holdings.
Nigel Green concludes: “The market is asking whether Japan will intervene.
“The question investors should be asking instead is: if Japan is, indeed, forced to intervene repeatedly, what assets will it have to sell to defend its currency?
“If the answer increasingly includes US Treasuries, then what appears to be a Japanese currency crisis today would rapidly become a global bond market crisis tomorrow.”
