The elephant in the room

What does that mean for US Treasuries and USD-denominated bonds in general?

The BoJ decision is extremely important not only for Japan but for the global bond market as a whole as the presence of Japanese real money is important in the US markets, and a change of monetary policy from the BoJ may mean that some of money invested in the US may be looking to return home.

As Japanese monetary policy didn’t change much Tuesday, we can expect Japanese real money to continue to flood the US market for longer and particularly to weigh on the longer part of the US yield curve as Japanese pension funds stay heavily invested in longer maturities (as they have to match payouts in the future).

The US market has been one of the favorite international markets for Japanese investors as it satisfies their risk-averse appetite and Treasuries have traditionally been viewed as a safe haven. Something, however, has changed over the past couple of years as Japanese investors have started to partially disinvest from Treasuries, aware that the hawkish policies of the Fed would have provoked these to fall in value.

Japanese money has found better opportunities in US corporate bonds and stocks for the time being, which continue to perform and provide a pickup compared to Treasuries.

While it is good news that real money is turning away from Treasuries as this could aid the steepening of the US yield curve, the bad news is that investors have been selling the shortest part of the curve in order to be able to move to other assets, thus causing an even more pronounced flattening of the US curve.

As we have mentioned many times, although an inversion of the yield curve does not cause a recession it has often preceded them and remains the best indicator for a US recession.

What can we expect from the Fed this afternoon?

In short? The Fed will not say anything new. The market will be scrutinising Jerome Powell's speech for any hint that the Fed might prove willing to make a U-turn and depart from the twice-more-in-2018, four-times-in-2019 hike schedule.

Another interesting factor that will get investors’ attention tomorrow is the President Trump's reaction to the meeting. Trump recently commented that “he’s not thrilled” about the Fed's decision to hike interest rates and although he soon retracted these comments by saying that he couldn’t care less what the Fed says, many are still speculating that the voluble president may well express his displeasure with the Fed is the statement is not to his liking.

Bond markets remain very dependet on monetary policy changes as central banks balance sheets remain large. Although the BoJ's decision is not a game-changer, it will add more pressure to US credits and might cause a faster flattening of the US yield curve.

From now until the end of this year we expect a bear flattener in the US, and we remain positive regarding the US investment grade space.