USD suffers mild sell-off as JGBs tank

USD: US dollar weaker ahead of US re-opening

The dollar selling yesterday and into today points to global investors making the assumption that the planned tariff action related to President Trump’s wish to purchase Greenland will either be revoked before the effective date of 1^st Feb or possibly that date will be pushed back in order to allow for discussions to take place between the US and Europe. That seems more plausible given it is highly unlikely to be resolved within two weeks and it is also highly unlikely that Trump would back down. The UK media is reporting that a call between Trump and Starmer on Sunday had helped convey the fact to Trump that he had misunderstood the reason the military personnel had gone to Greenland – could this help provide justification for cancelling the tariffs?

Our senior Economist has written our take on how this may play out for Europe (here) and there is no getting away from the fact that an escalation of a trade conflict that sees the current tariff rate at least doubled is disinflationary and would increase the prospects of the ECB cutting rates again this year. The OIS curve has barely budged although the 2-year yield did nudge lower yesterday, by 3bs. That again suggests to us that investors remain sceptical of these tariffs being realised, certainly for any meaningful time and investors certainly do not appear to give much weight to a notable escalation into a trade tariff war. But that perception could change quickly.

We also do not give much weight to the idea that this leads to a ‘sell America’ scenario, specifically by Europe. We were asked about this risk yesterday and Bloomberg did report on the potential for Europe to turn sellers of US assets either intentionally as a form of retaliation or more naturally as a reflection of Trump’s unpredictable policymaking that seems to invariably lead to trade tariff retaliation. Certainly the ‘sell America’ trade could return and European investors would play a role in that.

The intentional selling as a form of retaliation seems very implausible. Governments can hardly force private-sector investors to sell. A look at Treasury holdings data does indicate significant holdings by European investors – the UK USD 800bn; Belgium USD 399bn; Luxembourg USD 328bn; Switzerland USD 243bn; Norway USD 218bn are the largest. But many of these countries (UK for example) are used as intermediaries with the ultimate owner not from that country so the true holdings are much lower. Ireland owns USD 238bn but many US tech companies are the ultimate owners.

The most plausible scenario we see if turmoil related to Trump’s trade policies and other policies escalates further is a repetition, probably to a lesser degree, of what happened post-Liberation Day last year when heavy selling was more a reflection of increased appetite to hedge US dollar exposures. Flow data from that period showed moderate selling of US assets (in April) followed by record buying with investors seen as more interested in increasing hedge ratios. We think there is more of that to come. Certainly Japanese investors have scope to increase hedge ratios while dollar hoarding in China could diminish on increased expectations of further dollar weakness. The trade uncertainty, Fed independence threats, and Trump’s approach to geopolitics generally are all factors that could result in a sudden pick up in appetite for reducing US dollar exposures. The cost involved in that should also cheapen if we see the Fed deliver further rate cuts this year.

GROWING VALUE OF US BONDS & EQUITIES HELD BY FOREIGN INVESTORS

Source: Bloomberg, Macrobond & MUFG GMR

JPY: JGB meltdown will surely prompt a government rethink

UST bond yields are higher and no doubt yields in the UK and Germany will open higher later this morning following the huge sell-off of super-long JGBs in Japan. The 30-year and 40-year yields jumped 27bps and this move can only be described as a total rout that illustrates a complete loss of confidence in JGBs. Comments from Japan’s Growth Strategy Minister, Minoru Kiuchi certainly didn’t help. He appeared to play down the fiscal link to JGB moves stating that yields move for many different factors and that the government will be “mindful of fiscal discipline” when implementing the sales tax cut. A mixed result in a 20-year JGB auction also undermined confidence but a bid-to-cover of 3.19 was not exactly a disaster and was only modestly weaker than the 12mth average of 3.34.

JSDA data highlight the risk of over-dependence on foreign investors in the super-long sector of the JGB market. Foreign investors bought JPY 13.4trn worth of JGBs with a maturity over 10 years in 2025, which was an all-time high in the data series going back to 2005. Trust banks (used by pension funds) were the next biggest buyers but way back on JPY 4.7trn. Foreigners are being stopped out in significant intra-day moves that could have a lasting impact on sentiment. If foreigners turn their back on the JGB market we could see more days like we have had today.

This disruptive sell-off was ultimately self-inflicted and was triggered by PM Takaichi acknowledging that the LDP would include a sales tax cut on food for up to two years in the election manifesto. Investors know that the budget backdrop doesn’t provide scope for this to be financed by revenues and hence the assumption is that additional JGB issuance will be the source of funding. This underlines the perceived indifference of senior government officials and the PM to creating disruptive JGB market conditions and will only reinforce the potential for further selling.

Pressure is now going to build on the BoJ to step in as buyer of last resort. The BoJ is still allowing JGBs to fall off the balance sheet adding to supply although the pace of reduction in JGB purchases will slow from JPY 400bn per month to JPY 200bn in April. But outright buying if we get more days like today will become necessary. The BoJ being behind the curve is also creating selling pressure and this price action will pressure the BoJ to convey a more hawkish message to ensure inflation is brought back to target. The yen is notably weaker (mainly vs non-dollar crosses) and JGB market turmoil will likely reinforce yen selling ahead.

STRONG BUYING BY FOREIGN INVESTORS LAST YEAR UNDERLINED OVER-RELIANCE RISK

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com