Japan's "Butterfly" has stirred up a "storm" in the US bond market, impacting "global asset pricing".

Entering August, the storm of US Treasury bonds has caused the worst weekly performance since 2023 for long-term US government bond prices.

The 30-year US Treasury yield has risen nearly 25 basis points in the past three trading days, returning to the level seen in mid-November last year. The 10-year US Treasury yield also rose to around 4.13%, reaching a nine-month high on Thursday.

The volatility in the bond market has led to the trading volume of put options on 30-year US Treasury futures surpassing 100,000 contracts last week, the highest level since March. As the "anchor of global asset pricing," the soaring yields of 10-year and longer-term US bonds have been enough to raise high alert among all market participants, including stock market investors.

On the one hand, as pointed out by Wall Street News analysis, the dual blow of the US Treasury's large-scale debt issuance plan and Moody's downgrade of the US sovereign credit rating has ignited concerns about the US fiscal outlook, abruptly ending the bull market that lasted for five months, causing stocks and bonds to fall together.

On the other hand, perhaps all of this is inseparable from the "butterfly effect" that followed the surprise move by the Bank of Japan at the end of July. Are the major holders of US bonds, Japanese investors, pulling out? Is there no one to take over US long-term bonds?

Since the second half of 2022, the purchasing power of foreign investors, the main holders of US bonds, has declined. And with the subtle adjustment of the Bank of Japan's target range for benchmark bond yields, speculation about the normalization of monetary policy may increase the risk of funds flowing back from the US to Japan, further putting pressure on US bond prices.

Is there no one to take over US long-term bonds?

The Federal Reserve's overnight reverse repurchase agreement (ONRRP) can absorb some short-term debt but has difficulty digesting long-term bonds. The Bank of Japan's yield curve control adjustment has intensified the pressure on the demand side of US bonds.

Goldman Sachs pointed out in a recent report that the Bank of Japan's surprise move at its July policy meeting has become a catalyst for the rise in US bond yields and has made the global macroeconomic situation even more complex:

The consensus on duration rates in the market is being challenged as we enter the period of the most severe liquidity conditions in the summer.

The US Treasury Department announced that it will sell $103 billion in long-term bonds next week, exceeding the previous $96 billion: including $42 billion in 3-year US bonds, $38 billion in 10-year US bonds, and $23 billion in 30-year US bonds. This increase in supply still has an impact on long-term bonds. With a large influx of US bonds into the market, who will step in to take over? Billionaire investor and founder of Pershing Square Capital Management, Bill Ackman, admitted on Wednesday that he is "massively" shorting the price trend of 30-year US Treasury bonds through options. This move is aimed at hedging the long-term impact of rising bond yields on the stock market and also because he predicts substantial profits.

Ackman believes that the signal released by the Bank of Japan last Friday to adjust the Yield Curve Control (YCC) policy may eventually end the ultra-loose monetary policy, which would make Japanese bonds more attractive to the major "gold owners" of US bonds. If demand from Japanese investors weakens, it could further drive down US bond prices.

Speculation about the normalization of monetary policy may increase the risk of capital outflows from the US and European economies to Japan, putting further pressure on US bond prices.

In UBS's 10-year Japanese bond yield model, US bond yields and Japanese CPI are key explanatory variables:

If US bond yields continue to rise, Japanese bond yields will also continue to rise.

Peter Tchir, an analyst at investment bank Academy Securities, said that with the increase in Japanese government bond yields, this could mean that Japanese investors buying US Treasury bonds will decrease:

Japanese investors are major buyers of non-yen-denominated bonds, so as currency hedging decreases, Japanese holders will sell US dollar bonds.

The Next Game: October?

Although Bank of Japan Governor Haruhiko Kuroda has stated that there is no change in the ultra-loose policy, some analysts point out that the decision announced by the Bank of Japan at the end of July marked the end of the seven-year, controversial monetary experiment of Yield Curve Control (YCC). The Bank of Japan may follow other major central banks and tighten monetary policy to address inflation.

Luca Paolini, Chief Strategist at Pictet, believes that as the Bank of Japan abandons the YCC policy, funds will flow back to Japan from overseas. Japan is ending deflation and becoming a more normal investment destination.

Last Friday, analysts from UBS, including Masamichi Adachi, released a report stating that if forecasts indicate that the US will end or even avoid a recession earlier, the Bank of Japan may further expand the target range for yields at the interest rate meeting scheduled for October 31 and start a rate hike cycle in October 2024:

If the US does not enter a recession in the fourth quarter, the target for the 10-year government bond yield may be raised. In particular, if forecasts indicate that the US and global economies will remain resilient this year and beyond, the Bank of Japan may adjust the YCC policy again in October.