Speculators are descending on Tokyo again. Not the currency kind, but activist bond traders testing how tolerant the Bank of Japan is about rising yields. Gov. Haruhiko Kuroda’s answer: not very.
That’s the upshot of Thursday’s surprise move to buy “unlimited” Japanese government bonds at a fixed rate, a move aimed at regaining the momentum from Donald Trump’s shock election win. Kuroda threw down the gauntlet, saying “interest rates may have risen in the U.S., but that doesn’t mean that we have to automatically allow Japanese interest rates to increase in tandem.”
If you’re thinking “good luck with that, Kuroda-san,” you’re in good company. Count Japanese banks among those hoping he will fail to drive 10-year rates lower (sub-zero yields hurt bank profitability). But bond speculators, too, may be wise to bet against Kuroda’s ability to maintain the negative rate policy he’s toyed with since February.
Following the European Central Bank down the negative-rate rabbit hole was the second-biggest mistake of Kuroda’s 44-month tenure. The biggest was believing there was more to Abenomics than quantitative easing — that Prime Minister Shinzo Abe would deregulate a rigid economy and recalibrate fiscal engines. That’s left the forsaken central banker with the policy equivalent of throwing noodles at the wall. And negative rates, let’s face it, aren’t sticking. Look no further than the yen’s powerful rally this year and the BOJ pushing back the 2 percent inflation goal time and time again.
Kuroda underestimated that target’s ability to stymie his plans. On the one hand, constant talk of a 2 percent price jump made consumers and businesses more cautious. The thought of a radical change in living-cost dynamics only deepened the “deflation mindset” Kuroda aimed to end. On the other hand, bond traders are hypersensitive to the slightest whiff of inflation, one that arrived with Trump’s election.
The president-elect’s pledges for massive fiscal spending, building walls, starting trade wars and making the U.S. industrial complex great again sent shudders through global bond markets. It’s bringing to a head one of finance’s greatest paradoxes: how Japan pays off a public debt 2½ times the size of gross domestic product with a shrinking population and stagnant growth while also keeping bond yields below 1 percent, never mind zero. The global bond rout since Nov. 8 is testing the world’s most obvious asset bubble.
It’s easy to ignore the $10 trillion-plus Japanese elephant in the room when world finance powers meet. Japan Inc., after all, has been remarkably skilled at taming yields for decades. The reason: mutually assured destruction. When rates jump, the biggest JGB holders — banks, municipalities, pension funds, insurance companies, the postal savings operation, universities, endowments, companies, the fast-growing ranks of retirees — all get slammed. So the BOJ and Finance Ministry work in tight step to cap yields. Since 2013, Kuroda’s epic bond purchases acted like a powerful sedative to reduce yield-spike risks.
Trump’s victory changes that calculus, especially amid talk that Abe’s team may join his stimulus surge (the two men met in New York last week). One rationale would be to get in Trump’s good graces. Another: overcoming the fiscal hawks at the Finance Ministry. But Abe would only get away with a fresh borrowing binge if accompanied by pro-growth structural reforms. Massive public works spending without increased wages, productivity, innovation, labor-market flexibility, foreign influence in corporate boardrooms and upward mobility for women would add to Japan’s record debt burden and darken the credit-rating outlook. That would run decidedly afoul of the bond speculators bidding up yields. Hence Kuroda experimenting with what Sean Darby of Jefferies, a global investment bank, calls a “crude pegged exchange rate” policy aimed at bonds, not currencies.
None of this means JGBs are about to crash. As longtime Japan short-sellers like Kyle Bass of Hayman Capital Management can attest, this trade can be a widow maker. Even as Japan grew an annualized 2.2 percent between July and September, thanks to a jump in exports, Kuroda cautioned that private consumption remains “somewhat lacking momentum.” Not what the BOJ needs to reinflate Japan. Still, Abe could be mistaken in thinking the bond market will let his Liberal Democratic Party slip back into “construction state” mode. The U.S. needs a giant infrastructure makeover, one that would create jobs and increase competitiveness. In Japan’s case, it would offer a momentary GDP spurt, but regulatory headwinds undermining growth would soon reassert themselves.
Another building boom, one that just replaces first-rate infrastructure, does nothing to harness Japan’s enviable human capital, stable of patents and trillions of dollars of household savings. “Make no mistake about it,” say Carl Weinberg of High Frequency Economics, “this economy will contract over time as its population declines.”
That’s just what worries bond speculators testing Kuroda’s ability to maintain control of a bond market getting trumped by global uncertainty. If Kuroda were hoping for a quieter 2017, he can forget it.
William Pesek is executive editor of Barron’s Asia. www.barronsasia.com
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