Japan's Downgrade is Bearish For U.S. Treasuries

The recent rally in U.S. Treasuries has many of us wondering when the trend is going to end. One party disruptor may be Japan, a major foreign creditor holding some $900B of U.S. Treasury debt, second only to China, who holds ~ $1.15T. Japan may yet decide to liquidate some of its holdings to divert capital to post-tsunami rebuilding efforts or to invest in higher yielding debt or other investments elsewhere.

Japan's recent sovereign credit rating downgrades are perhaps warranted, but a tad nonsensical in comparison with a lack of an actual downgrade of U.S. sovereign credit. Though Japan's government debt/GDP approaches ~220% of GDP, the U.S. debt/GDP at ~100% of GDP is growing at a much faster rate and does not account for unfunded obligations that will easily exceed projected tax revenues.

The Yen carry trade that financed arbitrage-fancy T-bond purchases is not as lucrative as it once was, given the persistent strengthening of the Yen (USD/JPY is now trading again below 80). Given the U.S. debt profile, sitting on long-term U.S. debt has growing risks unless hedged. The Bank of Japan could see a sale of Treasuries and a purchase of higher yielding debt from other countries with stronger currencies as a prudent move as Treasuries continue to push higher on what I call a technical rally.

(Major foreign holders of Treasury securities are tracked by the Treasury here: http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt.)