What will Japan use in trade deals with the US?

However, nobody believes that Japan would use this card – not even Japanese policymakers? Steven Barrow, Head of Standard Bank G10 Strategy, doesn’t expect Japan to threaten to sell treasuries. But he thinks that sales are likely to happen anyway.

Japan holds just over USD1tr of treasuries out of total overseas holdings that are close to USD9tr. That’s a decent sum and hence something that stirs emotions when there is any sort of talk that Japan might sell, and especially if it were to do so quickly in a fit of pique over US tariffs. But there’s always the comeback that sales would depress prices and end up costing Japanese investors more.

There is also the view that there are few alternatives to treasuries in terms of things like market size, liquidity and safety. The Bank of Japan also tends to use the dollar/yen market when it intervenes and hence may have a preference to hold treasuries in its reserves.

More recently, there’s another argument, which is that using treasury sales as a threat against the White House could backfire with the Administration imposing even bigger tariffs on the country. So, for all manner of reasons, it has generally been assumed that Japan won’t use its treasury holdings as a ‘card’ in trade discussions with the US.

“We agree with that. However, this is not the same as saying that Japanese holders of treasuries from both the public and private sector should hold onto treasuries at all costs. It would be silly of Japanese investors to hang onto, or even increase, treasury holdings if the market looks unattractive and, in many respects it is looking unattractive right now. We do not necessarily mean this in terms of the outlook for treasury prices, even if a surge in inflation seems to be coming down the track. Instead, we mean that treasuries arguably don’t look attractive for Japanese investors for a whole host of other reasons”, said Steven Barrow.

One is that the large treasury market size might actually be more of a problem than a positive trait because it has encouraged huge amounts of trading that ultimately leaves the market unstable and suffering liquidity meltdowns. Here we could talk about the hedge-fund generated basis trade between cash and futures prices that seemed largely responsible for the meltdown in the market last month, forcing President Trump to backtrack on tariffs.

A second aspect is that some of the foundations of the market seem to be creaking. Here we might include the foundations of government that are under pressure from the Trump Administration and possibly the foundations of monetary policy as well given political pressure on the Fed to ease policy.

A third aspect is that the currency-hedged yield on treasuries is not good relative to JGBs given the wide gap in policy rates between the US and Japan. Right now, the 1-year US dollar/yen forward is some 3.5% below the spot rate, and that clearly eats up a good deal of any treasury yield advantage. Of course, Japanese buyers of treasuries can leave the currency unhedged, but that may be even worse. The yen is still historically very weak (and undervalued) against the US dollar, the BoJ has been intervening to sell US dollars, and it is very likely that the US Administration (or at least Trump) wants to see a lower US dollar/yen, even if a commitment to reduce US dollar/yen from Japan is not part of any trade deal.

The bottom line in Steven Barrow’s view is that Japan has every reason not to threaten to sell treasuries but every reason to actually sell treasuries. That’s exactly what China has done. For a decade ago its treasury holdings were around USD1.25tr. Now they are less than two thirds of this level at USD784bn. This might be understandable if reserves had collapsed; but they have fallen by only around 8% over the period. As far as we are aware, China has sold all these treasuries but never threatened to sell them; Japan might just do the same.