Trading Day: Japan spreads long bond relief

Reuters

27-05-2025

ORLANDO, Florida, May 27 (Reuters) - TRADING DAY
Making sense of the forces driving global markets
By Jamie McGeever, Markets Columnist
Reasons to be cheerful
A tariff reprieve from U.S. President Donald Trump, a surprise bounce in U.S. consumer confidence and a slide in government bond yields sparked a rally across most markets on Tuesday, particularly U.S. assets, with Wall Street, Treasuries and the dollar all outperforming.
In my column today I look at how much the dollar may need to fall if the Trump administration is to succeed in making a significant dent in the U.S. trade deficit. More on that below, but first, a roundup of the main market moves.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
Today's Key Market Moves
Japan spreads long bond relief
Global liquidity returned to more normal levels on Tuesday as UK and U.S. markets re-opened after the long weekend, and investors mostly scooped up whatever they could get their hands on.
There were good reasons to feel bullish: President Trump extending his deadline for imposing 50% tariffs on European Union goods to July 9, relief at the long end of the Japanese Government Bond market, and a spike in U.S. consumer confidence.
There will be more back-and-forth in Trump's tariff pronouncements in the weeks ahead, and there is a case to make that each positive turn will deliver diminishing returns for markets. The next big deadline is July 9, when Trump's pause on his reciprocal tariffs with the rest of the world also expires.
Similarly, consumer confidence in the U.S. and elsewhere is liable to be volatile, difficult to predict amid such heightened uncertainty, and susceptible to the tariff headlines of the day.
That said, if Trump's tariffs deliver a one-off price shock and no lasting inflationary pressure beyond that, consumer confidence may continue to improve. Economists at Citi, for example, forecast year-end inflation of 3.2%, not too much higher than the current rate of around 2.5-2.7% and well below some of the gloomier forecasts of 4% or higher.
Perhaps the most interesting market moves of the day came from Japan, where ultra-long JGB yields clocked some of their steepest one-day falls after sources told Reuters the Ministry of Finance may consider trimming issuance of long-dated paper.
These yields had last week spiked to record highs on growing jitters about Tokyo's deteriorating public finances and an alarming drop off in investor demand. Tuesday's rally in JGBs spread to long-dated U.S. bonds, which have also come under heavy selling pressure on concerns about Washington's fiscal indiscipline and drawn weak demand at auction too.
Analysts at Morgan Stanley on Monday recommended going outright long on 10-year Japanese Government Bonds at 1.505%, which was the yield's high that day. But they remain more cautious on the long end, despite Tuesday's rebound.
A more "lasting solution" to the recent market turbulence, they argue, will require an increase in Bank of Japan purchases or less supply from the Ministry of Finance. Or both.
Looking ahead to Wednesday, the global session will kick off with an expected interest rate cut in New Zealand, span a 40-year bond auction in Japan and a five-year note sale in the United States, and wrap up with chipmaker Nvidia's quarterly earnings after the Wall Street close.
Historic dollar fall needed to eliminate US trade deficit
If the United States is to significantly reduce or, whisper it, eliminate its trade deficit, the dollar will probably have to weaken a lot. How much is unclear, though, as history shows large dollar declines are rare and have unpredictable consequences for trade.
Reducing the U.S. trade deficit is the key goal of Trump's economic agenda because he believes it reflects decades of other countries "ripping off" America to the tune of hundreds of billions of dollars annually.
Stephen Miran, chair of the Council of Economic Advisers, published a paper in November titled "A User's Guide to Restructuring the Global Trading System" in which he argued that the dollar is "persistently over-valued" from a trade perspective. "Sweeping tariffs and a shift away from strong dollar policy" could fundamentally reshape the global trade and financial systems.
If a weaker exchange rate is the Trump administration's goal, it is on the right track, with the greenback down nearly 10% this year on the back of growing concerns over Washington's fiscal trajectory and policy credibility, as well as the end of "U.S. exceptionalism" and the "safe haven" status of Treasuries.
But it is good to remember that a 15% fall in the dollar during Trump's first term had no impact on the trade deficit, which remained between 2.5% and 3.0% of GDP until the pandemic. Making a dent in the U.S. deficit will therefore require a much bigger move.
Reducing the trade deficit will be a challenge, eliminating it without a recession, a historic feat. The United States has run a persistent deficit for the past half-century, as insatiable consumer demand has sucked in goods from around the world and voracious appetite for U.S. assets from overseas has kept capital flowing stateside.
The only exception was in the third quarter of 1980, when the U.S. posted a slender trade surplus of 0.2% of GDP, and trade with the rest of the world almost briefly balanced in 1982 and 1991-92.
But these periods all coincided with - or were the result of - sharp slowdowns in U.S. economic activity that ultimately ended in recession. As growth shrank, import demand slumped and the trade gap narrowed.
The dollar only played a significant role in one of them. In 1987, the trade gap was a then-record 3.1% of GDP. But it had almost disappeared by the early 1990s, largely because of the dollar's 50% devaluation from 1985-87, its biggest-ever depreciation.
That three-year decline was accelerated by the Plaza Accord in September 1985, a coordinated response between the world's economic powers to weaken the dollar following its parabolic rise in the first half of the 1980s.
But that does not mean large depreciations always coincide with reductions in the trade deficit.
The dollar's second-largest decline was a 40% fall between 2002 and mid-2008, just before Lehman Brothers collapsed. But the U.S. trade deficit actually widened throughout most of that period, peaking at a record 6% of GDP in 2005. While it had shrunk by more than three percentage points by 2009, that was due more to plunging imports during the Great Recession than the exchange rate.
These two episodes of deep, protracted dollar depreciation stand out because over the past 50 years, the dollar index has only had two other declines exceeding 20%, in 1977-78 and the early 1990s, and a few other slides of 15-20%. None of these had any discernible impact on the U.S. trade balance.
The U.S. administration is correct that the dollar is historically strong today by several broad measures. Given that Trump and Treasury Secretary Scott Bessent seem intent on rebalancing global trade, pressure on the greenback looks unlikely to lift any time soon.
But how much would the dollar have to fall to whittle away the yawning trade deficit, which last year totaled $918 billion, or 3.1% of GDP?
Hedge fund manager Andreas Steno Larsen reckons a 20%-25% depreciation over the next two years would see the deficit "vanish," while Deutsche Bank's Peter Hooper thinks a 20%-30% depreciation could be enough to "eventually" narrow the deficit by about 3% of GDP.
"This means that a significant reversal of the roughly 40% appreciation of the dollar in real (price-adjusted) terms against a broad set of currencies since 2010 could be sufficient to get the current deficit back to a zero balance," Hooper wrote last week.
History suggests this may be challenging without a severe economic slowdown. But that's a risk the administration seems prepared to accept.
What could move markets tomorrow?
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