Japan’s Bonds Now Pay 2.90%. That’s a Problem for Your Mortgage Rate.

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Updated 1115 ET

The ten-year Japanese government bond closed Thursday at 2.90%. Futures markets put the probability of a Bank of Japan rate increase in September at 87%, taking the policy rate to 1.25%.

Japan is the largest foreign creditor of the United States. It holds $1.203 trillion of Treasury debt, ahead of the United Kingdom at $889 billion and China at $683 billion.

For three decades those holdings made sense for a simple reason. Domestic yields were near zero, so a Japanese life insurer or pension fund had to go abroad to find income. That condition has now ended.

Run the comparison the way a Tokyo investment committee runs it. The American ten-year yields 4.665%. A yen-based buyer who hedges the currency pays away roughly the gap between short-term rates in the two countries, currently about 2.6 percentage points with the Fed at 3.50% to 3.75% and the Bank of Japan at 1.00%.

That leaves a hedged American ten-year returning somewhere near 2.0%, against 2.90% available at home in the investor’s own currency with no hedging required. Dealers quote hedging costs of 3% to 4% a year depending on tenor, which widens the gap rather than narrowing it.

Japan’s Finance Ministry is planning for the same reality. It is considering raising the assumed interest rate it uses for debt-servicing calculations to 3.8% for the 2027 fiscal year.

The question is not whether Japanese institutions like American debt. It is whether they are paid to own it. For thirty years the answer was yes by default, because there was no alternative at home. At 2.90% domestic against roughly 2.0% hedged offshore, the default has flipped. Nobody has to sell a single Treasury for this to matter. They only have to stop reinvesting when the current ones mature.

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THE OPERATION

Follow the carry

Size the position before judging the risk. The Bank for International Settlements put direct cross-border bank borrowing in yen at $261 billion at the middle of this year. Add off-balance-sheet derivatives and the figure approaches $1 trillion. Count the broader set of positions that depend on cheap yen funding and an Atlantic Council analysis in July reached $11.3 trillion.

That is the yen carry trade. Borrow where money is nearly free, lend where it is not, and pocket the difference. It has been the quiet plumbing beneath a great deal of global asset pricing, and it works only while the first half of that sentence remains true.

Japanese officials are now saying out loud that it will not. Deputy Governor Ryozo Himino said the central bank remains vigilant to inflation risks and will discuss the need for further tightening. Seiji Adachi, a former member of the policy board, expects a rate increase next month and another as early as January.

The currency has been doing the arguing for them. The Finance Ministry spent 11.73 trillion yen, roughly $72.7 billion, defending the yen between late April and late May. The yen strengthened to 155 to the dollar in early May, drifted to 157 by the middle of the month, and reached 162 by late June. Officials have warned that holding rates unchanged risks reigniting the selloff and importing inflation through it.

So the Bank of Japan is being pushed toward tightening by its own currency, and every step it takes raises the return on staying home for the institutions holding $1.203 trillion of American debt.

Note the timing against the American calendar. The federal debt crossed $40 trillion nine days ago. The Treasury doubled buybacks of its own long-dated paper on the nineteenth, and the relief lasted a single session. July inflation came in at 3.7% against a 3.6% forecast, and futures now price better than a 70% chance of a Federal Reserve increase by December.

Washington needs the long end of its curve to behave at precisely the moment its largest foreign creditor acquires a domestic alternative that pays more. This is not a political decision and no announcement will mark it. It is an accounting outcome, arrived at independently by fund managers in Tokyo doing arithmetic that used to have only one answer and now has two.

RULES OF ENGAGEMENT

Where the buyer goes

The Bank of Japan meets in September and is 87% priced to move. Watch what happens to the ten-year Japanese yield afterwards rather than the policy rate itself. A domestic yield through 3% makes the case for repatriation on its own, without any view on the dollar.

Read the text of Warsh’s first Jackson Hole keynote as chair, which the Kansas City Fed posts to its site as he begins speaking at 10:00 Eastern this morning. Read it for one thing in particular: whether he addresses the Treasury’s buyback programme. Silence concedes the long end to the fiscal side. Criticism opens a public dispute with the Treasury Secretary two and a half weeks before the September 16 policy meeting.

Watch the thirty-year rather than the ten-year for the Japanese signal. Life insurers and pension funds buy duration to match long-dated liabilities, so if repatriation is running it shows up at the far end of the curve first, which is the same part of the curve the Treasury is spending money to support.

Two other dates sit inside the next fortnight. Canada’s matching tariffs on roughly $20 billion of American goods begin on September 8. The Federal Reserve decides on September 16.

For anything priced off the long end, the operative fact is that the marginal buyer is changing character. Gold at $4,595 an ounce and a real ten-year near 0.97% are both consistent with a market that has noticed. Refinancing decisions that assume the recent dip in yields is structural are betting on the buyback rather than on the buyer.

The exposure is a creditor who no longer needs the debt. Japan holds $1.203 trillion of Treasuries because for thirty years home paid nothing. Home now pays 2.90% in yen, against roughly 2.0% for a hedged American ten-year, and the Bank of Japan is 87% priced to widen that gap in September. The United States crossed $40 trillion in debt this month and had to bid for its own bonds to steady the long end. The buyer of last resort is quietly becoming a seller of first resort, and no press conference will announce it.

END OF TRANSMISSION.

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