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The BOJ’s QT, inflation that’s higher than in the US, an atrocious fiscal mess, a devalued yen, it all comes together.
By Wolf Richter for WOLF STREET.
Japan, which now has substantially more inflation than the US – 3.6% overall CPI and 3.2% core CPI – is watching in astonishment as its very-long-term bond yields spike in a dramatic manner, while the Bank of Japan has accelerated QT this year, which it started in mid-2024.
The superhero is the 40-year JGB yield, which jumped another 11 basis points at the moment, for a spike of 100 basis points since the beginning of April, to 3.56% at the moment. A rising yield means a falling price.
Despite the breathtaking spike, the 40-year yield is still a hair below the rate of Japan’s overall inflation rate, and thereby a hair negative in real terms, and new bond buyers are still getting ripped off in terms of yield.
And bond holders that bought new 40-year bonds a few years ago when the 40-year yield was below 1% or even below 0.5% are getting crushed on price, because a yield spike like this in a very-long-term bond means that the market price of the bond collapses. If they don’t want to take the loss selling it, they can hold the bond to maturity, collecting a miserable 0.5% or whatever in coupon interest a year, for decades, and then finally get paid face value when the bond matures, and the purchasing power of that face value will be much diminished by decades of inflation. Inflation without compensation.
Japan’s credit rating – A1 by Moody’s, A+ by S&P – is three notches worse than the blemished US credit rating (my cheat sheet for bond credit ratings).
Prime Minister Shigeru Ishiba, when he argued in Parliament on Monday against tax cuts funded by more debt issuance, called Japan’s financial situation “extremely poor, worse than Greece’s,” which it has been for many years in terms of its debt-to-GDP ratio. But Japan is not Greece. It has its own currency and sits on trillions of dollars in foreign-currency denominated securities, including $1.13 trillion in US Treasury securities, that it can sell to prop up the yen, and it’s a major exporter of high-value manufactured goods. But the yen did plunge against the USD and other major currencies over the past few years.
Despite the yield-spike, and despite Japan’s fiscal problems and inflation, the 40-year yield is still below the US 30-year Treasury yield, which earlier today briefly flirted with 5.0% again.
So these 40-year JGBs are still a terrible deal, which had become clear to potential buyers, and they lost interest. And so the yield is rising, trying to find buyers, now that the BOJ has started shedding its own holdings.
But the BOJ still holds 52% of all JGBs, and paper losses (or actual losses) don’t matter to a central bank. And government-controlled entities hold another big portion of JGBs. Despite Japan’s huge debt, not all that much is in private hands.
The 30-year JGB yield jumped 11 basis points to 3.09% at the moment, after a majestic spike, as market participants grapple with the prospect of continued and possibly hotter inflation – because hotter inflation is a way to deal with the fiscal mess at this late stage – and they’re grappling with the scary notion that the BOJ, now surrounded by inflation, will no longer be the relentless bid in the bond market that will push prices back up and yields back down. That era may be over.
Yen carry trade less attractive? Very long-term yields in this range are beginning to offer an alternative to the yen carry trade. Japanese investors can still borrow at low short-term rates in Japan but invest in long-term JGBs, instead of selling the yen for dollars and buying US securities with higher yields. Sticking to yen investments would avoid the risks and costs associated with foreign currency investments. If these high long-term yields progress, they would drain some buyers from foreign markets, such as the US Treasury market.
All these trades are risky, and a lot of things can go wrong, including sharp interest-rate moves and currency moves, but years of central bank yield repression leads to risky yield chasing.
The 10-year JGB yield has risen in a much more modest manner to just 1.53% currently, less than half the rate of inflation, thereby steeply negative in real terms, and thereby a massively ugly deal. But it’s up from the negative yields it experienced off and on from 2016 through 2019.
This long-term chart shows that even the Japanese bond market used to be a fairly normal bond market until the 1990s when the falling debris from the implosion of the 1980s asset-price bubble kept hitting the economy.
QT accelerates. The BOJ has reduced its holdings of JGBs by ¥25 trillion ($172 billion) from the peak in February 2024 through March 31, the end of its fiscal year. This has brought holdings to ¥576 trillion ($3.98 trillion), the lowest level since December 2022.
The BOJ’s government securities holdings move in three-month cycles due to the timing of when long-term bonds mature and when they’re replaced with newly issued bonds of the same type. In terms of this three-month cycle, the peak of government securities holdings was the period of October-December 2023. Compared to December 2023, its JGB holdings fell by ¥16.3 trillion ($112 billion).
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The post Japan’s 30-Year and 40-Year Bonds Crater, Yields Spike, Huge Mess Coming Home to Roost. Yen Carry Trade at Risk appeared first on Energy News Beat.
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