Shuli Ren, Bloomberg
It’s happening again. From Japan to the US, the world’s biggest government bond markets seem increasingly unstable, prone to flash crashes.
On Tuesday, what began as a quiet trading day in Tokyo quickly morphed into chaos. Yields on the country’s ultra-long bonds jumped by more than 25 basis points, reminiscent of a similar episode last May. A selloff in the US market followed, with the 30-year yield hovering near its late 2023 peak. Japan’s longer maturity bonds rebounded on Wednesday after Finance Minister Satsuki Katayama called for calm.
In the super-long segment, foreigners have been most prominent in recent months, lured by the higher rates Japan now offers. Domestic insurers, on the other hand, have started selling their holdings, because they have less need to hold 40-year bonds to earn income for their policyholders. After all, the more liquid 20-year notes already broke above 2% by mid-2025.
When selloffs in Japan started to take hold on Tuesday, overseas asset managers scrambled to rebalance their portfolios. Some de-risked and covered their losses, not knowing how bad things could get. Others had fear-of-missing-out, selling Treasuries to fund their purchases of Japanese bonds.
Either way, volatility spiked all the way to New York. Macro hedge funds that specialize in risk-parity trades — an investment strategy that allocates capital so each asset class contributes equally to the portfolio’s total risk — were likely forced to cut their bond holdings, thereby exacerbating the meltdown.
But the root cause of the Treasury rout runs much deeper than rising Japanese bond yields and their spillover effects. President Donald Trump has let the genie out of the bottle and can’t put it back.
Last April, Trump blinked and paused tariff hikes on all nations except China — after watching US sovereign bonds tank. As a result, Treasuries have become more than a financial instrument. They are now a pawn on the high-stake geopolitical chest board. Wealthy economic blocs will want to use this to their advantage.
There’s now talk of European countries weaponizing their $3.6 trillion holdings to force the White House to back down from taking Greenland “the hard way.” Whether they actually do it doesn’t matter. The fact that there’s a potential big seller out there is enough to put downward pressure on US debt.
Trading dynamics and negotiation tools aside, there’s an even more damaging factor that could lead to future routs. Namely, does it even make sense to hold developed countries’ government bonds?
Wall Street has been questioning the 60/40 model. It’s a classic way to build a portfolio, comprised of 60% in stocks and 40% in bonds which serve as a cushion when equities tumble. But in 2022, bonds’ diversification effect failed to kick in, causing the model to incur its worst year since the Global Financial Crisis.
Morgan Stanley, for instance, has proposed an alternative 60/20/20 strategy, swapping out some fixed income for gold, arguing that the precious metal is a better inflation hedge. Gold hit another record high this week.
Meanwhile, from a total returns perspective, developed nations’ sovereign bonds haven’t rewarded long-term investors. They’ve been in the red, with Japan dishing out the ugliest performance.
Global bond markets are looking like a house of cards, and one wonders how they can add value to wealth portfolios. We have not seen the ugliest meltdowns yet.
[Abridged]
Courtesy Bloomberg/Shuli Ren
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