Is it a sign of a full-fledged economic recovery or a looming catastrophe in the monetary making?
Recent spikes in Japan’s long-term interest rate, represented by the 10-year government bond, have created a stir and roused a deep sense of alarm among investors and powerful politicians.
A confident Bank of Japan Gov. Haruhiko Kuroda fired his credit-easing “bazooka” in April by ordering his BOJ to start purchasing massive amounts of JGBs while pledging to push down the long-term rate, assuring the public that the strategy will pull the economy out of its long-running deflationary slump.
But on the contrary, after hitting a trough of 0.315 percent on April 5, the yield on the benchmark 10-year JGB surged to 0.92 percent Wednesday, the highest in 13 months.
That remains far lower than in other developed countries, but the spike was surprising enough to shock the market because it could signify that Kuroda’s plan is flawed. Japan is struggling under a staggeringly high government debt worth as much as 200 percent of gross domestic product.
A sharp rise in long-term rates could drastically increase Japan’s debt-servicing costs and trigger a crisis for the government, which needs to keep issuing massive amounts of government bonds just to finance the ever-growing deficit.
“If the interest rate goes up, it would have a direct impact on the debt-servicing costs of government bonds,” economic and fiscal policy minister Akira Amari said at a news conference Tuesday.
“The government and the BOJ will keep making efforts to reduce volatility through good communications with the market and by firmly managing government bonds,” Amari said.
The stakes are huge. According to a 2011 simulation by Sumitomo Trust Bank, if the long-term interest rate rises 1 point, it would increase the government’s debt-servicing costs by as much as ¥10 trillion in 2020.
Meanwhile, other ministers are trying to play down the significance of the jump in the long-term rate, arguing that it’s a sign of economic recovery and that an investment shift is under way from the stock market to the bond market.
The Nikkei 225 stock average topped 15,000 Wednesday for the first time in more than five years.
“Recently, stock prices have soared very rapidly. Money is just shifting from bonds to stocks,” Chief Cabinet Secretary Yoshihide Suga said at a recent news conference. “We won’t comment on interest rates but will continue to closely monitor” the JGB market, he added.
Izuru Kato, chief economist at Totan Research Co., agreed that the spikes in the long-term rate can mainly be attributed to investors’ expectations for a full-fledged economic recovery. He doesn’t believe the rate will immediately lead to a catastrophic crash of the JGB market.
But at the same time, Kato warned that the JGB market has become unstable and is highly sensitive to outside shocks.
At present, the BOJ is buying long-term JGBs worth a staggering ¥7 trillion from the market every month, and this operation is crowding out other players.
Kato said that as a result, the liquidity of JGBs has decreased considerably, meaning financial institutions are now finding it difficult to quickly find counterparties to buy or sell large volumes of the bonds.
Kato also pointed out that most of the JGB buyers, other than the BOJ, are mainly limited to Japanese financial institutions, which all have similar risk-management policies.
In market conditions like this, the long-term interest rate “could easily spike instantly” and create a vicious circle in which selling of JGBs would prompt more selling from other parties.
Kuroda’s aggressive JGB-buying operation has “seriously damaged market functions,” Kato said.
“I don’t think the JGB market will crash immediately, but turmoil on the market could be repeated” if an outside shock occurs, such as if the U.S. Federal Reserve Board were to end its latest round of quantitative-easing measures.
To prevent a catastrophic crash of the JGB market, it is essential for the government to draw up and implement a clear long-term program to reduce the snowballing government debt, Kato said.
But at least for now, the priority for politicians in power appears to be winning the Upper House election in July, not restoring fiscal health.
In June, the Council on Economic and Fiscal Policy, a key advisory panel for the prime minister, will compile his basic economic and fiscal policies, including mid- to long-term targets for curbing the mounting national debt.
Shinzo Abe’s Cabinet has pledged to maintain the official goal of halving the deficit in the primary budget, a key indicator for the government’s fiscal conditions, by fiscal 2015 and turn the balance into a surplus by fiscal 2020.
But Chief Cabinet Secretary Suga created a stir by suggesting the government should review those goals, during an April 22 session of the council.
Another senior official said he believes the council “will only briefly” mention primary balance goals in compiling the basic fiscal program next month.
“Basically, we will discuss this issue only after the election,” the official said on condition of anonymity.