It’s taken nine years and the Bank of Japan supersizing its balance sheet to the $5 trillion mark, but Asia’s second-biggest economy finally has some inflation.
Officials in Tokyo are realizing the hard way, though, that it’s best to be careful what you wish for as bond yields spike.
Granted, the gains in consumer prices Japan is reporting are negligible compared to those in the U.S. and China. And inflation is still a good distance from the BOJ’s 2% target. Still, the 0.5% rise in consumer prices in January year-on-year is already unnerving the bond market. It followed a 0.8% jump in December and marks the fifth straight month of increases.
The worry is that Japan’s inflation is the “bad” kind. Haruhiko Kuroda was hired as BOJ governor in March 2013 to end deflation. Kuroda unleashed tidal waves of liquidity. That drove the yen down 30%, generated record corporate profits and sent Nikkei 225 Average stocks to 31-year highs.
Yet even after swelling the BOJ’s balance to the point where it topped gross domestic product, inflation remained elusive. The reason: a dearth of bold reforms left corporate CEOs timid about hiking wages or investing big in new innovation.
Then came Covid-19. As economies reopen and supply chains go awry, global inflation spikes are zooming Japan’s way. Surging costs of energy and other commodities have Japan importing the inflation the BOJ hoped to generate organically at home. And bond traders don’t like it.
In recent weeks, yields on 10-year government debt rose to a six-year high of 0.2%. This won’t seem problematic, considering comparable U.S. Treasury securities yield 1.93%. But then Washington’s debt is nowhere near the 250% ratio to GDP that Japan faces. Nor is America’s population shrinking and aging at troubling rates year after year.
The rate spike was enough to catalyze Kuroda’s team to smooth things over in Tokyo’s $12 trillion public debt market. Earlier this month, the BOJ intervened to enforce its “yield-curve control” policy for the first time since 2018.
For this, there are two clear takeaways. One, the idea the BOJ will be tapering anytime soon is rather fanciful. Two, Japan’s bond market could become a bigger risk to global financial stability than investors realize.
The first debate was a lively one just a few months back. At the end of 2021, indications were that Japanese GDP was stumbling back toward pre-Covid levels. The annualized 5.4% growth Japan recorded in the October-December period put it firmly on the path back to the 2019 range.
Yet the BOJ is haunted by past efforts to end the quantitative easing that’s been the Japanese norm since 2001. Back in 2006 and 2007, for example, then-BOJ Governor Toshihiko Fukui ended QE and managed to raise short-term rates away from zero with two tightening moves. By 2008, Fukui’s successor returned Japan to zero and QE.
Japan, as Kuroda has learned, is addicted to free money. The national government, provincial leaders, banks, corporate chieftains and investors grew accustomed to zero rates. Any BOJ effort to wean the economy off the monetary sauce goes badly very quickly. So, BOJ tapering in 2022 seems a non-starter.
And yet the bond market could be vulnerable to stumbles that rapidly go global.
To be sure, a Japanese bond crash has been something of a widow-maker trade this last decade. Short-sellers betting Japan’s crushing debt would go awry underestimated the BOJ’s resolve to maintain calm. They also seemed to miss the cornerstone role government IOUs plan in Japan.
Sure, that’s true of most nations. In Japan’s case, though, government bonds are the financial equivalent of the sun, around which all else orbits. They are the main asset anchoring banks, companies, endowments, insurance pools, local governments, pensions, the postal system, the massive ranks of retirees, universities and any other institution you can name.
The entire Japan Inc. universe, in other words, has an overriding incentive to keep the peace in the bond realm. And yet, that’s becoming harder as the inflation Kuroda & Co. wanted for years begins to arrive.
Tokyo is now one of three colossal markets in harm’s way amid Covid-19 dislocations. The U.S. is suffering the biggest inflation spikes in 40 years just as the national debt tops $30 trillion.
In China, President Xi Jinping’s efforts to reduce leverage among property developers collided with Covid-related dislocations. By the end of 2021, global markets were gyrating in response to defaults by China Evergrande Group, Fantasia Holdings, Kaisa Group and others.
And now Japan is experiencing its own dose of activist traders bidding up debt yields. When the globe’s three most-watched debt markets, arguably, are on shaky ground simultaneously it’s hard not to worry.
Sure, Team Kuroda has some tricks up its sleeves to maintain the financial peace. But as inflation arrived, its ability to control the ticking time bomb that its $5 trillion balance sheet has become can no longer be taken for granted.