The Department of Treasury just announced that it is launching a buyback program from May through July. On the surface, this looks like we are restarting quantitative easing. I think this is precisely because of Japan-related risks that I’ve been highlighting since August. After a miserable, failed intervention by the Bank of Japan to stabilize the yen, the next step might be the Bank of Japan selling some of its Treasury holdings.
What are the mechanics to this? What do Treasurys have to do with the yen?
The way the process works is that the Bank of Japan liquidates some of its holdings of U.S. government bonds, converting the proceeds from these sales into U.S. dollars. Following this conversion, the BoJ would then sell the U.S. dollars in the foreign exchange market in exchange for Japanese yen. The increased demand for yen, because of these transactions, puts upward pressure on its value. Simultaneously, the supply of U.S. dollars in the market increases, which can lead to a relative weakening of the dollar.
In essence, this intervention mechanism aims to correct imbalances and support the yen’s purchasing power, aligning with the BoJ’s mandate to maintain currency stability and economic health.
Could it be the case that Treasury Secretary Janet Yellen knows this and is trying to front-run the ongoing supply of Treasurys from Japan by providing a cushion through repurchases?
What Is Going on With Treasurys?
I don’t think that’s far-fetched at all. That’s exactly what I would do if I were in charge. It’s clear Yellen is growing more concerned about interest rates. Just yesterday, she said that “the U.S. needs significant steps to reduce the budget deficit.” She’s saying this as yields rise at the margin over the last few weeks, with the looming threat of even higher yields from Bank of Japan Treasury selling.
The risk, of course, is that this strategy completely backfires. If bond vigilantes smell blood in the water, then yields could push up even further on inflationary concerns that come from the Treasury basically purchasing debt with more debt. It could also create a deflationary pulse if this is the first step to policymakers sacrificing stocks to save Treasurys.
This is a very interesting development. I think Yellen knows that Japan can upend the financial markets through Treasury selling. That, combined with deficits, becomes a nasty scenario she must likely front-run. And if that’s the case, a lot more volatility could be coming.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
