Japan’s bond market sell-off is no blip
The so-called ‘quiet riot’ in the country’s debt market could be a foretaste of things to come
On Tuesday, the publication of a report showing that the US services sector last month expanded at its weakest pace in six years caused the yield on benchmark 10-year Treasury bonds to fall by a further seven basis points to 1.53 per cent, taking its decline since the end of June to more than 20 basis points.
German 10-year bond yields have also fallen since Britain’s shock decision on June 23 to vote to leave the European Union.
Indeed, according to data from JP Morgan, benchmark yields in every other advanced economy, as well as those in many emerging markets, have dropped sharply as the post-Brexit rally in the sovereign debt markets continues apace.
Yet one country – and an extremely important one at that – is suddenly bucking the global trend of falling bond yields.
In Japan, the word’s second-largest government debt market, yields have been rising over the past several weeks. Japan’s 10-year bond yield has shot up nearly 30 basis points since July 27 and is now almost in positive territory having been below zero since late February.
To be sure, some 65 per cent of Japanese government bonds (JGBs) are still negative-yielding. Yet the proportion has decreased from 80 per cent at the beginning of July, according to JP Morgan, which also notes that the average yield in Japan is now slightly positive, having hit a historic low of minus 0.12 per cent as recently as July 6.
What is happening in Japan’s bond market?
Part of the reason for the sell-off in JGBs has to do with the announcement by the Bank of Japan (BoJ) at its policy meeting at the end of July that it will conduct a “comprehensive assessment” of its three-year-long ultra-loose monetary policies amid a fierce domestic backlash against its controversial decision in late January to introduce negative interest rates.
This unsettled investors who, having already lost confidence in the BoJ’s commitment to meet its seemingly elusive 2 per cent inflation target (Japan’s core inflation rate currently stands at just 0.5 per cent), interpreted the decision as a sign that the BoJ is about to scale back, or “taper”, its purchases of longer-dated JGBs.
On Monday, Haruhiko Kuroda, the BoJ’s governor, insisted that Japan’s central bank has no plans to begin withdrawing monetary stimulus and that “there is ample room for further easing,” possibly as soon as the central bank’s eagerly awaited policy meeting on September 20-21.
Yet markets remain extremely sceptical of the effectiveness of the BoJ’s policies – and rightly so given a loss of credibility and repeated failures of communication.
The yen, Japan’s currency, has strengthened 15 per cent versus the dollar since the end of January, precisely the opposite effect intended by the BoJ’s policies.
The recent rise in Japan’s bond yields, however, could imply a more severe loss of confidence in monetary policy.
According to Jeffries, an investment bank, the “quiet riot” in the JGB market could suggest that “markets have begun to realise that the ‘frontier’ in [quantitative easing] policies is drawing to a close”, with investors now pinning their hopes on premier Shinzo Abe’s recently unveiled fiscal stimulus programme to lift growth and inflation.
If this is the case – and there are strong indications that it may well be – then this marks a turning point for central banks’ ultra-accommodative monetary policies.
As the Bank for International Settlements, the so-called ‘central bankers’ bank’, warned in its latest annual report published at the end of June, global monetary policy has been “overburdened” for far too long. Investors have become “increasingly dependent on central banks’ support” even through the “room for policy manoeuvre has narrowed.”
Japan is the first country in which there appears to be a concerted attempt to pass the economic stimulus baton from the central bank to the government – or at least reduce the over-reliance on monetary policy as the main source of stimulus.
This is a welcome development, but one which, if successful, carries significant risks for the bond market.
Bank of America Merrill Lynch is warning investors to prepare for the “Keynesian put”, or greater levels of government spending to boost growth and inflation.
While this could be a boon for some parts of the equity market, bonds could come under severe strain if inflation rises sharply.
The “quiet riot” in Japan’s debt market could be a foretaste of things to come.
Nicholas Spiro is a partner with Lauressa Advisory