By Jonathan Rogers Forget the sudden plunge in Japan’s benchmark stock index, surging government bond yields are far more worrying, says IFR Asia’s Jonathan Rogers.
SO THE VERSION of events being touted by Japan bulls is that last week’s one-day 7.3% plunge in the Nikkei represented simply a pullback for a market that had put in its most supercharged performance over six months since 1953. This presents a major buying opportunity for those who believe “Abenomics” and the newly pugilistic Bank of Japan will drag Japan out of its two lost decades - or so the story goes.
But was Thursday’s stock market collapse about equities or really all about bonds? I suspect the latter, as the equity meltdown unfolded after a capitulation in Japanese government bonds that saw yields spike to their highest in a year. Bank of Japan governor Kuroda spoke on Friday about calming bond markets, but ever since he announced the mammoth quantitative easing programme in April the JGB market has turned into a quivering mass of uncertainty bordering on terror.
It might just be that now the easy money has been made by punting on Japanese equities, a slower grind higher is on the cards after last week’s “correction”.
But I‘m not convinced it was simply a correction. Rather, it might have been something closer to a realisation that for all the brouhaha of Abenomics, the “three arrows” and the shed-loads of money printing, the Japanese financial authorities are losing the plot.
HEDGE FUND MANAGER Kyle Bass, whose Hayman Capital fund has returned 25% a year since 2006 and who correctly bet against US mortgage-backed securities, reckons a full-blown Japanese financial crisis is around the corner. And that’s because the old status quo of household saving, current account surpluses and low fiscal deficits has been chucked out of the window. There are more spenders than savers in Japan, and the country is close to facing a current account deficit as well as running a budget deficit of more than 10% of GDP.
Meanwhile, Japan’s public debt to GDP is approaching 230%, the highest percentage of any nation in the world, with the debt largely funded domestically.
A Tokyo-based Japan funding head for a European bank told me last week that bank investors in JGBs had been “shell-shocked” by the recent capital losses they had sustained on their JGB portfolios, and were panicking about how to protect themselves against further losses.
That wasn’t the Kuroda script at all - monthly purchases of JGBs were supposed to pull yields down. But then there’s the Alice in Wonderland absurdity of announcing a 2% inflation target as an explicit policy goal and not expecting that nominal yields will have to rise in anticipation of higher real yields in the future, assuming the target is achieved. The market bought that argument over the alternative that JGB purchases by the BoJ would put a ceiling on yields.
YOU HAVE TO wonder whether last Thursday was a turning point for global financial markets. Collapsing Japanese equities had a knock-on effect on Asian, European and US equities, while JGB yields spiked to their highest in a year and 10-year Treasuries pushed through 2%. Blame was placed on the vaguest of hints from Bernanke that QE3 was about to be tapered off as well as weak manufacturing data from China.
But might it not have represented a moment of clarity among market players that something is really not quite right in the global economy? Are investors finally noticing that central banks have been forced to resort to desperate measures that represent the failure of ordinary monetary policy, and that fiscal policy in the US, Japan and Europe is no more about fine-tuning but how to confront mountains of debt that threaten to bring the whole house tumbling down?
THE GREAT US economist JK Galbraith observed that “anything unsustainable cannot be sustained” and it seems that nowhere is that more apposite than when it comes to the Japanese government bond market. It might well have been that the JGB market could have kept chugging along at record-low yields as long as Japan’s leaders were willing to accept low growth and deflation as the status quo.
Indeed, the former BoJ governor Masaaki Shirakawa regarded Japan’s deflation as structural, and based on the country’s woeful demographic of an ageing and declining population.
Now, Prime Minister Shinzo Abe’s grand ambitions threaten to turn the spotlight on the unsustainable nature of the JGB market, which Bass has likened to a Ponzi scheme.
The bankers in Tokyo tell me there is a widespread mindset of panic among institutional holders of JGBs and that can’t be a good thing. Panic tends inevitably to lead to crisis, and goodness knows, after the eurozone crisis - which I refuse to believe has had a line drawn under it - global financial markets could hardly deal with another crisis without contagion on a massive scale.
In order to stem panic-selling in JGBs, the BoJ will have to undertake a buying programme of a far greater size than initially envisaged and one that simply might not be viable given Japan’s precarious fiscal position.
I suspect the JGB market is about to take centre stage among the variables that dictate the actions of global financial market players, and that its role will be unequivocally that of the villain. Mr Abe might soon come to wish that he had kept Japan chugging along. His grand vision, for all its laudable intentions, seems likely to soon be revealed as fundamentally self-defeating.