Even though inflation data came in better than expected, U.S. Treasury yields are still rising, and Wall Street speculates that "Japan is the driving force behind the scenes."

The wave of U.S. Treasury selling continues, and the market is turning its gaze to Japan. Even though inflation data unexpectedly softened, the 10-year U.S. Treasury yield still climbed to a multi-decade high of 5.28%, and Wall Street analysts are engaged in a fierce debate over exactly how Japan is driving this global bond market turmoil. On Thursday, despite core PCE data coming in below expectations, U.S. Treasury yields continued their rise, dashing market expectations that "cooling inflation would ease selling pressure." Both Yardeni Research and Deutsche Bank pointed the finger at Japan, but their judgments on the transmission mechanism were completely different - the former believes yen carry trade unwinding is the main cause, while the latter argues that the rise in Japanese government bond (JGB) yields itself is the key. The core implication of this debate is that when the U.S. Treasury selloff stops may depend on whether Japan can stabilize its own bond market. Goldman Sachs' latest report shows that CTA trend-following funds' net short positions in the global bond market have reached -$170 billion (measured in DV01), and are still expanding, indicating that market pessimism over the bond market outlook has spread to historical extremes. Two interpretations: carry unwind or rate repricing? Ed Yardeni, President and Chief Investment Strategist at Yardeni Research, noted in a report that investors using the yen as a funding currency for carry trades may be exacerbating the global bond selloff. He believes that as the Bank of Japan (BOJ) raises rates, carry traders are forced to sell government bonds from various countries that they had previously purchased with cheap yen loans. "This trade once allowed many governments to run fiscal deficits without pushing up bond yields. Now it is time to pay the bill." Ed Yardeni also pointed out that during the period when the BOJ and other major central banks pushed borrowing costs to unusually low levels, governments borrowed heavily and accumulated enormous debt. He characterized the current situation as the revenge of the "bond vigilantes" - a concept he himself proposed and popularized in the 1980s. However, Shoki Omori, Chief Japan Fixed Income Strategist at Deutsche Bank, questioned this logic. He argued that carry trade unwinding would mechanically drive the yen higher and leave a fixed market "fingerprint": the yen jumping, speculative yen shorts collapsing, stocks falling, and U.S. Treasuries rising on safe-haven demand. "But the current price action shows completely opposite characteristics," he said. "Bonds and the yen are falling together. This is a signal of inflation and rate repricing, not deleveraging." Fund flow data also supports this judgment. Weekly data from Japan's Ministry of Finance show that in the two weeks ending September 12, Japanese residents were net buyers of foreign long-term bonds (net buying of 1.1 trillion yen in the week of September 6-12), after net selling 2.8 trillion yen in the second half of August; at the same time, non-residents were net buyers of Japanese long-term bonds for four consecutive weeks, buying 2.2 trillion yen in the week of September 12 alone. Shoki Omori interpreted this as "foreign capital flowing into JGBs while Japanese funds flow out again," exactly the opposite of the logic of capital returning home. Consensus amid disagreement: the root of the problem lies in the Japanese bond market Although the transmission mechanisms are disputed, analysts on both sides agree on one point: the root of the U.S. Treasury selloff points to Japan, with the core being turmoil in Japan's own bond market. Goldman Sachs strategist Isabella Rosenberg noted in a latest report, "What Are JGB Spreads Signaling About Fiscal Risk," that since May, JGB swap spreads have widened across the entire curve as yields rose. She noted that JGBs have performed better than expected relative to swaps - that is, swap yields have risen more than bond yields - which makes the argument that "JGB supply and its absorption problems are driving the selloff" difficult to sustain, in contrast to market performance after the previous removal of yield curve control (YCC). Goldman Sachs believes that the relative strength of JGBs may reflect multiple factors: lower long-end issuance, optimistic market expectations for domestic demand (especially policy developments related to GPIF and NISA), and a marginal easing of long-end rate supply pressure at the policy level in major economies such as Japan, the United States, and the United Kingdom. However, Goldman Sachs also warned that in the medium term, given that JGB issuance is expected to increase next year and the BOJ continues to shrink its balance sheet, swap spreads should return to a more narrowed level. In other words, if the Japanese bond market cannot stabilize, it will be difficult for U.S. Treasury selling pressure to ease substantially, and most long-term Japanese bond yields are currently at historic highs. Political constraints make it difficult for the BOJ to act What worries the market even more is the BOJ's policy space. New Prime Minister Sanae Takaichi has expressed dissatisfaction with recent rate hikes and plans to replace several BOJ board members with dovish candidates, which means the BOJ lacks the political will to tighten policy further. Against this backdrop, the 10-year JGB yield has risen to a historically rare high, and the market clearly believes that the BOJ's rate hikes are far from enough to curb Japan's persistently rising inflation. Treasury Secretary Bessent's recent high attention to the situation in Japan also indirectly confirms the profound impact of the Japanese bond market on U.S. Treasury trends. Currently, CTA trend-following funds' net short positions in the global bond market have reached -$170 billion and are still expanding week by week, reflecting that bearish bets on the global bond market have reached historical extremes. However, Goldman Sachs also cautioned that once deflation signals or a clear economic slowdown appear, short positions in U.S. Treasuries and JGBs may face the most violent short squeeze in history. This article is reprinted from "Wall Street See", author: Zhao Ying; GMTEight editor: Chen Siyu.