With the U.S. debt ceiling crisis set to reach boiling point between June and August, it already promises to be a long hot summer for financial markets.
Aside from the unprecedented stress in short-dated U.S. T-bills right now, markets seem to be unprepared for the risks. But the BOJ has the ability to surprise - remember December last year? - and inflation is high, while history shows the U.S. Congress certainly has the ability to push debt ceiling negotiations to the brink.
Japan is the world’s largest creditor with a net investment position of $3.2 trillion, according to the International Monetary Fund. Japanese investors own more than $4 trillion in debt instruments overseas, around half of which is “portfolio investments.” The potential flow into the yen if even a fraction of that is sold is huge.
Congress probably will reach agreement before it’s too late, like it has done 78 times since 1960. But it could still go to the wire, creating huge market stress as the ‘X-Date’ looms. On top of that, the U.S. banking shock has accelerated flows into money market funds - their aggregate balance has shot above $5 trillion, and MMF flows are a large chunk of the $2 trillion-plus that institutions park daily at the Fed’s RRP.