- Japan’s bond and currency selloff has been the most spectacular.
- JGB selloff is taking place at a time when Japan’s private market is thriving.
- The yen may require some intervention given the risk of irking the US.
- In other DM markets, the higher yields are also a reflection of market conditions normalising.
- Central bank credibility and fiscal-monetary coordination could keep the bond boat steady.
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Commentary: JGB selloff and implications
Japan’s 10-40 year bond yields hit highs not seen since the 1990s last week. A snapback on Friday may have brought some respite, but yield rise of the magnitude seen in the past year is worrisome for an economy with public debt/GDP ratio of 235%. The drama was also in Japan’s currency market, with the yen briefly flirting with 160/USD before making a recovery. For an economy characterised by persistent current account surplus (over 4% of GDP per year lately), this development is also unusual.
The market’s verdict is clear: the Bank of Japan is behind the curve in normalising monetary policy, and the government of Japan has fallen short in its path toward debt consolidation. But the overall market is not necessarily in turmoil. After all, the rise in public debt yield should be in the context of an economy humming with private capital market activity for the first time in many decades, with flourishing M&As and a soaring domestic stock market. Japan’s public sector debt is a source of concern, but the overall economy’s momentum looks unlikely to be dragged down by that issue. Still, the yen, which in our view has overshot a great deal, may require some intervention, especially given the risk of irking the US.
Some other DM sovereign bond yields are also at decadal highs. Germany’s bond yields have nudged up in recent weeks, with expectations of higher defence spending gathering momentum. US and UK are also hovering around territory that would have been considered uncomfortable just a few years ago. In these cases, we would apply the same context as the Japanese one. Yields are elevated because of high debt burdens, no doubt, but they don’t reflect concerns about debt sustainability, in our view. Globally, demand and inflation are running on the higher side, which would be consistent with higher nominal interest rates. DM economies should focus on debt consolidation, but they are by no means in crisis territory. The market is justified in demanding higher risk premium, having received exceptionally low rates of return from public debt securities for a decade and a half.
Implicit in the relatively orderly state of the market through the selloff is belief in central bank independence and perhaps expectations of some monetary-fiscal coordination to keep things stable. If these beliefs remain anchored, we think DM debt issuance and service can continue apace. The authorities better not push the market too much in these matters.
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