Japan Sells Over $60B US Treasury Bonds

Other countries hold U.S. Treasury bonds as a core component of their financial strategy, but the risks associated with these holdings can be enormous and have widespread implications.

One of the primary risks is interest rate fluctuations.

When U.S. interest rates rise, the value of existing Treasury bonds declines.

For countries holding a large amount of U.S. Treasury bonds, this can lead to significant losses, especially during periods when inflationary pressures lead to unexpected interest rate hikes.

Another key risk is exchange rate volatility.

U.S. Treasury bonds are denominated in U.S. dollars, meaning foreign holders face currency risk.

If the U.S. dollar depreciates against their local currency, the value of these investments decreases when converted back to their local currency.

This situation is particularly disadvantageous for countries with currencies that fluctuate significantly or are appreciating.

In recent years, due to changes in economic conditions, global exchange rate volatility has intensified, making this risk more pronounced.

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Inflation also poses a threat to the value of U.S. Treasury bonds.

If the U.S. inflation rate exceeds the yield of these securities, the real return value for foreign holders will shrink.

Given the recent inflation trends following global economic turmoil, this risk has become an urgent concern for countries relying on these investments to maintain the value of their foreign exchange reserves.

Inflation can significantly erode the purchasing power of their investment returns.

Political and geopolitical risks further complicate this situation.

Domestic political debates in the U.S., such as discussions surrounding the federal debt ceiling, can trigger uncertainty about the government's ability to fulfill its debt obligations.

Even the threat of a technical default due to political deadlock can shake global confidence in U.S. Treasury bonds, leading to market turmoil.

Moreover, geopolitical tensions between the U.S. and other countries can lead to sanctions or restrictions on access to U.S. financial markets, making U.S. Treasury bonds less reliable for some foreign governments.

Liquidity risk also plays a role during periods of global financial instability.

Although U.S. Treasury bonds are generally considered to be highly liquid assets, during periods of market stress, large holders may find it difficult to sell these bonds quickly without affecting the price.

This can be particularly troublesome for countries that need to quickly convert their holdings into cash during a crisis, as a sudden sell-off can depress the market value of their investments.

Additionally, countries like China and Japan, which hold a large amount of U.S. Treasury bonds, also face concentration risk.

Over-reliance on a single asset class can expose these countries to significant losses when the U.S. financial system is under great stress or the U.S. dollar depreciates significantly.

Given the vast scale of their holdings, it is difficult for these countries to exit these positions without negatively impacting the market, further exacerbating the risk.

As of September 2024, Japan remains the largest foreign holder of U.S. Treasury bonds, although its holdings have experienced significant fluctuations this year.

In March 2024, Japan's holdings were around $1.87 trillion, but by May 2024, Japan's holdings dropped to approximately $1.128 trillion, due to a series of sales totaling $59.5 billion, including a $22 billion sale in May and a $37.5 billion sale in April.

These sales are part of Japan's efforts to intervene in the foreign exchange market to support its weak yen.

The yen has been under pressure due to the widening interest rate gap between Japan and other major economies, such as the U.S., leading Japan to spend billions of dollars in recent months to combat currency speculation.

Japan has already spent over $36 billion in interventions alone, demonstrating its strong commitment to stabilizing the yen.

Japan's recent decision to reduce its holdings of U.S. Treasury bonds stems from a variety of strategic considerations.

Japanese financial institutions, including the Norinchukin Bank, face significant unrealized losses in their bond portfolios.

To mitigate interest rate risk and rebalance their investment strategies, they are turning to assets with different risk exposures, such as credit risk of corporations and individuals.

For example, Norinchukin Bank plans to sell $63 billion worth of U.S. and European government bonds to cope with a net loss of 1.5 trillion yen in the fiscal year.

The depreciation of the yen has intensified the pressure, with the yen-to-dollar exchange rate falling to its lowest level in 34 years.

In response, the Japanese Ministry of Finance intervenes in the foreign exchange market, typically by selling dollar-denominated assets (such as U.S. Treasury bonds) to support the yen.

The strategy aims to curb the depreciation of the yen, which would otherwise drive up the cost of imports and exacerbate inflation.

In addition, Japan's shift away from its negative interest rate policy is reshaping investment dynamics.

As domestic interest rates rise, Japanese government bonds become more attractive to local investors, offering competitive returns without the exchange rate risk of foreign currency bonds.

This reduces the appeal of U.S. Treasury bonds.

The Japanese economy also faces broader structural challenges, including stagflation and an aging population.

By reallocating capital from U.S. Treasury bonds to domestic bonds and other assets, Japan hopes to enhance its economic stability.

This strategic shift helps ensure that more investments flow into supporting domestic growth and mitigating the impact of ongoing financial market pressures.

Japan's decision to reduce its holdings of U.S. Treasury bonds could affect the value of the U.S. dollar and contribute to a gradual global trend away from dollar dominance, a trend often referred to as "de-dollarization."

As one of the largest holders of U.S. Treasury bonds, Japan's actions could push up U.S. Treasury yields, as bond prices typically fall and yields rise when major holders sell off.

Higher yields would increase the cost of servicing U.S. debt, potentially reducing the attractiveness of the dollar as a global reserve currency over time.

However, the scale of Japan's sales is crucial for assessing its broader impact.

While significant, Japan's sales are unlikely to shake the dollar alone.

Yet, this move reflects a broader global trend where countries are gradually diversifying their international trade and reserve holdings away from reliance on the dollar.

This trend is amplified by geopolitical factors, such as U.S. sanctions on multiple countries, making some nations more cautious about over-reliance on the dollar.

As a result, the use of alternative currencies like the Chinese yuan is increasing in bilateral trade agreements.

Economic fundamentals also play a role.

The U.S. interest rate hikes driven by the Federal Reserve to curb inflation make dollar-denominated debt more costly for foreign holders, prompting countries to look for cheaper financing options.

At the same time, a stronger dollar increases the cost of maintaining large dollar reserves, further driving the motivation to seek alternatives.

In this context, Japan's sale of U.S. Treasury bonds reflects both imminent economic pressures and a broader "de-dollarization" trend.

While Japan's individual contribution may seem moderate on its own, if Japan were to sell off a large portion of its holdings of U.S. and European government bonds, the impact could ripple through the financial markets of both regions.