For close to twenty-nine years, Japanese government bonds resided in an obscure provincial area of the international bond markets. Returns remained astronomically depressed, typically staying within a few basis points of zero, as the Bank of Japan maintained an extremely accommodative monetary policy to stimulate economic growth and fight Japan’s persistent deflation. That long innings is now ending much sooner than anticipated. On Monday, the yield on the five-hundred yen, ten-year JGB surged to 2.93%, its highest level since September 1996. This occurred despite newly released statistics indicating the economy expanded at a much slower rate than analysts forecasted. The difference is huge.
Japan’s gross domestic product grew at an annualised rate of just 1.1 percent in the April-to-June quarter, far short of the 2 percent that most economists had been expecting. Consumer spending stagnated and business investment dropped. Growth so anaemic should have dragged bond yields down, on the expectation that the Bank of Japan would loosen policy. But they stayed on the rise on a different set of influences that nowadays matter more to markets than soft growth data. The culture of yen weakness is now the primary focus. The falling unit has raised the price of imported energy and manufactured goods, adding inflation at a time when oil prices have also risen because of tensions in the Middle East.
Speculators are waking up to the fact thatthe Bank of Japan will have little option but to, in the words of one analyst, ‘rubber stamp’ rate rises, to defend the yen and control prices. Markets are now pricing in some 80 percent chance that the central bank will move as early as its September meeting. So, the policy-sensitive two-year yield has ‘rattled higher to levels not seen in three decades’. Fiscal concerns are coming on top of this.
Japan already has one of the highest public debt loads vis-a-vis the size of its economy. A recent series of government spending and tax-cut packages has fuelled doubts over just how much more bond issuance might be necessary. When investors fret over the supply of fresh debt they charge a higher premium to hold it.
What you get is a market looking beyond sluggish recent growth to target inflation worries and the prospect of stricter policy. For the everyday Japanese househoulds and firms, the change is not trivial. Increased long-term rates will slowly translate into higher mortgage, corporate borrowing costs and returns on savings. Having experienced almost-zero rates for years, it will take time for many households and firms to move to a world in which saving has an obvious cost. Exporters, who gained from the yen’s weakness, face the risk that its support will diminish if the increased rates draw capital to Japan and lead to the rise of the yen. Meanwhile, the higher cost of debt could reduce investment at a point when domestic demand already appears weak.
