Japan spreads long bond relief

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

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.

I'd love to hear from you, so please reach out to me with comments at jamie.mcgeever@thomsonreuters.com. You can also follow me at @ReutersJamie and @reutersjamie.bsky.social. 

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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 the pause on Trump's reciprocal tariffs with the rest of the world also expires. 

Similarly, consumer confidence in the US 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 exeample, 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 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 chip-maker Nvidia's quarterly earnings after the Wall Street close.

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 President Donald 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.

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