LIVE MARKETS-Rising Japanese yields have global bond markets on edge

Welcome to the home for real-time coverage of markets brought to you by Reuters reporters. You can share your thoughts with us at markets.research@thomsonreuters.com

RISING JAPANESE YIELDS HAVE GLOBAL BOND MARKETS ON EDGE

Activity within Japanese markets has suddenly moved to the front burner. And as Philip Palumbo, founder, CEO and chief investment officer at Palumbo Wealth Management, sees it, a sudden rise in long-term Japanese yields has the potential to throw global bond markets into a panic.

"For more than 30 years, Japanese interest rates have been among the lowest of any industrialized nation. Consequently, Japanese investors have used their yen - and those outside Japan have borrowed it - to invest at higher rates in other countries, particularly the United States. This strategy has been used for so long it even has a specific name: the yen carry trade," writes Palumbo in a note.

Palumbo adds that U.S. markets have been a main beneficiary of this demand, which at the margin tends to put downward pressure on U.S. interest rates and upward pressure on U.S. stocks. However, he cautions that the recent increase in Japanese rates may have put the yen carry trade on thin ice.

According to Palumbo, Japan remains the largest foreign holder of U.S. Treasuries, with more than $1 trillion in holdings. It has played a key role in funding the massive U.S. government deficit by purchasing Treasury bonds at attractive yields compared to local Japanese rates.

However, with inflation picking up, it appears that the BOJ is gradually shifting away from its ultra-low-rate policy. In addition, a massive stimulus package proposal as well as the suspension of some taxes has stoked concerns that this will worsen Japan’s already massive public debt burden.

Thus, bond buyers are now demanding higher yields to compensate them for greater risk.

"In short, the Japanese bond vigilantes are beginning to speak up. Any rapid unwind of these carry trades could cause very significant volatility in the global bond markets that would likely roll over into the global equity markets - a ‘Japanic Attack’, if you will," writes Palumbo.

His bottom line is traders may be on edge, but he thinks long-term investors need not react as this will eventually even out, whether fast or slow.

"Long-term investors should be prepared for the possibility of some short-term volatility."

(Terence Gabriel)

EARLIER ON LIVE MARKETS:

LPL FINANCIAL NOW AMONG POSSIBLE S&P 500 ADDITIONS CLICK HERE

"RUN IT HOT" TAKES A DETOUR TO ENSURE IT REACHES ITS DESTINATION - MS CLICK HERE

US STOCKS EDGE UP IN EARLY TRADE BUT COMMODITY WEAKNESS CONTINUES CLICK HERE

DIVIDENDS BOLT OUT OF THE GATE, WHILE GROWTH IS THE GLUE - CLICK HERE

DRIVERS BEHIND GOLD RALLY STILL POWERFUL DESPITE PULLBACK - BARCLAYS CLICK HERE

WHY A FED UNDER WARSH MAY BE TOO HAWKISH CLICK HERE

EUROPEAN SOFTWARE: WHEN FEAR CLOUDS FUNDAMENTALS CLICK HERE

DEFENSIVES HELP STOXX LIMIT THE DAMAGE CLICK HERE

BEFORE THE BELL: FUTURES FALL AS METAL ROUT HITS MINERS CLICK HERE

METALS GET A LOT LESS PRECIOUS AS POSITIONS SQUEEZED CLICK HERE