Perfect Storm Brewing in FX and Bond Markets as US and Japan Intervene

The recent joint US-Japan currency intervention has raised concerns about a potential perfect storm in the FX and bond markets. The US Treasury market, worth $29 trillion, is vulnerable to significant Japanese selling of Treasuries, which could drive up borrowing costs and trigger an economic and market crash.

Japan's exposure to US debt stands at $1.14 trillion, making it America's biggest international creditor. While no one expects Tokyo to willingly spark a crisis, accidents can happen, particularly now. The extreme weakness in the yen, stress in Japanese government bonds (JGBs), and parts of the Treasury curve are all contributing factors.

The intervention last week was likely aimed at preventing volatility in JGBs from spilling over into the US bond market, where longer-term yields were already hitting multi-decade highs. Any unraveling of the ties between the world's two biggest bond markets could have ripple effects through the financial system.