What happens to Japan when everyone else is doing a Japan

Strange things are afoot in the Japanese bond market. Yesterday, China cut the reserve ratio requirement for banks by 50bp, the first RRR cut since May 2012 (the third of the BRICs to ease this year, following India’s surprise January 25bp cut and Russia’s 200bp cut last week). We already know that yields are plummeting in the developed economies. But not Japan. The sell off has continued ever since the spike following the ECB QE decision. 10 year yields have doubled from their 0.22% lows (see 1st chart), while the 5yr has snapped back aggressively from trading at negative yields to just over 0.10% today:

10yr JGB 5yr JGB

 

What is going on?

Re-allocation looks like a large part of the answer. The Government Pension Fund announced last year that it would be moving away from JGBs to assets with higher yields; insurance companies can’t meet their payouts at negative rates so they are moving into riskier assets (Dai-ichi Life insurance is looking at real estate); and ECB QE means that you can find better yields elsewhere, in a market where you know a central bank will be buying right behind you.

The thing is, this wasn’t really supposed to happen. The BOJ are also right behind everyone, after unexpectedly upping their QQE programme last October. As you can see from the charts, JGB yields merrily plummeted from that point onward. But it looks like there comes a point when other parts of the market just decide that they’re better off out of it, and go looking elsewhere for yield. That point would appear to come when the middle of the curve trades at negative rates. What is the point of buying a 5 year bond with a sub-zero yield? Better to move further out the curve… but then what if the 10year isn’t yielding much more for the extra 5 years? Then you go looking for other assets.

This should be a warning for Germany. Their 5 year has been trading in negative yield territory since the middle of January, even before QE was announced:

Germany 5yr

You can see that it’s been bobbing around zero ever since. Meanwhile the 10year is coming down – currently at 0.34% it’s not quite at Japan’s 0.22% levels, but it’s not that far off:

Germany 10y

Now, part of the attraction of QE for Europe is what Draghi calls the “portfolio” effect, where it shifts investors into riskier assets, thus kickstarting lending etc. But what if the growth and reflation isn’t there when that happens? Is this where Japan now finds itself? If it is, what could Japan do?

Last night a new appointment to the BOJ board was made: Yutaka Harada, who wrote a book called “Reflationist Economics Saves Japan”. He believes so firmly in the power of reflation that he pointed out in the book that Japan’s suicide rate reached its peak in the 2000s, concluding “If the economy gets better, we can save one-third of those committing suicide”. In a 2002 Bloomberg interview he said “If the BOJ buys all of the bonds from Japan’s debt market, that will create inflation without a doubt. That’s it.”

So perhaps we may see some renewed easing efforts from the BOJ…. without that, Yen strength will be back on the radar as Abenomics First Arrow fails.

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