Deutsche Bank analysts highlighted an emerging trend in the financial markets, indicating a potential shift in the global economic landscape.
The bank observed that the Japanese yen (JPY) is strengthening against the US dollar (USD) even as US Treasury yields rise, suggesting a decline in foreign participation in the US Treasury market. This development comes despite an increase in Japanese back-end yields, which some market participants have interpreted as a sign of growing fiscal concerns in Japan.
However, Deutsche Bank disagrees with this interpretation, pointing out that the yen’s strength contradicts the notion of rising fiscal worries in Japan.
The bank’s analysis suggests that Japan’s fiscal position remains robust due to its positive net foreign asset position. Deutsche Bank argues that the sell-off in Japanese Government Bonds (JGBs) poses a more significant issue for the US treasury market. As JGB yields become more attractive, Japanese investors may increasingly opt for local assets over US Treasuries, leading to further divestment from the US.
Deutsche Bank’s perspective on the coming months centers on the idea that markets are increasingly influenced by external asset positions, exerting combined downward pressure on both US bond markets and the USD. The bank uses a metric known as the beta of the Net International Investment Position (NIIP)/yield relationship to gauge market concern over the US’s twin deficits. This beta has remained within a defined range since the Global Financial Crisis.
The analysts at Deutsche Bank suggest that risks are tilting towards a steeper beta curve, indicating a potential widening in the differentials between the US and the Rest of the World (RoW). This shift could signal a return to the pre-2008 regime. In their FX Blueprint, Deutsche Bank posits that a weakening USD could serve as a release valve for America’s twin deficit problem, allowing for adjustments in economic imbalances.
