Treasury investors have not flinched so far, even as the U.S. dollar’s strength has forced the yen to 34-year lows against the greenback, and the Bank of Japan (BoJ) executed its biggest currency intervention in years this spring, on behalf of the Japanese Ministry of Finance. But they may not always be so sanguine if Japan continues to intervene and other Asian countries follow suit, Yu writes in a May client note. The draining of central bank dollar reserves as they prop up their currencies could ultimately increase selling pressure in the Treasury market, he explains.

Here’s why: foreign central banks often intervene by selling dollars, and if the intervention is large enough, they may sell Treasury reserves to replenish their dollar liquidity buffers. Japan’s late-April and early-May intervention reportedly may have cost the BoJ more than $50 billion, according to estimates by some commentators. Yu warns that if the dollar remains high for months to come – and that’s likely if the Federal Reserve continues to hold off on rate cuts – not only is Japan likely to intervene again, but the potential for intervention in other Asian currencies may rise.

“With the jury still out on the efficacy of Japan’s intervention, it could become viewed as an opening salvo in a new round of intervention by Asian central banks,” Yu writes.

Ironically, the yen’s recent weakening was exacerbated by the BoJ’s landmark decision to drop its eight-year-old negative interest rate policy in March. Investors seemed unimpressed with the token rate increase, and Yu believes it is unlikely the yen will find major support until Japan significantly increases rates. That leaves the BoJ with currency intervention as its only tool. It appears our clients have similar views: BNY Mellon iFlow data show clients are holding long positions in the yen forwards market, suggesting they expect the BoJ will continue intervening until the Ministry of Finance raises rates again.

Yu says another way the Treasury market could be affected is if a strong U.S. dollar constrains emerging market trade surpluses, potentially leaving developing economies with fewer new dollars to buy Treasurys for their reserves.

A temporary decline in foreign central bank buying is unlikely to break the Treasury market, but it is one more worry for investors as the U.S. government’s deficits and debt servicing outlays rise. Foreign central banks are some of the U.S. Treasury’s most routine buyers and their presence helps to keep bond prices in check, according to Yu.

He believes Japan will change its tack and opt for smaller, more frequent interventions to smooth out currency volatility, now that larger interventions don’t appear to be stopping the yen’s slide.