Japan’s Ministry of Finance has taken an audacious step in its bond issuance strategy. That’s because they are continuing to pare back their inventory of long-term bonds while increasing the supply of short-term debt. Regardless of the merits of the decision, this ruling has created waves through the nation’s financial services markets, creating fear and uncertainty among investors and financial regulators. These changes have had significant effects. Now even Japan’s long-end government bonds (JGB) are experiencing never-seen-before volatility.
In a move that has left market analysts reeling, Japan’s long-end yields did not merely experience fluctuations. They have effectively “blown a hole straight through the yield curve.” The 30-year JGB yield sank by a record breaking 18 basis points. This decline indicates a major repricing of the risk of the country’s long-term debt. After all, the 40-year JGB is now trading as if it’s been put on junk status watch. This extreme overall fragility is fuelling fears that the strong underpinnings of Japan’s financial infrastructure are beginning to crack.
Japan’s life insurers are already starting to feel the sting from these tectonic shifts. They are now swimming under the weight of an estimated ¥8.5 trillion in paper losses. With these losses comes the urgent question of whether their business models are sustainable in a fast-changing economic environment. In the meantime, analysts have been warning that Japan’s gigantic debt load of ¥172 trillion is very much a ticking time bomb. This funding beast threatens to overshadow the financial sector.
From the very highest levels, Japanese policymakers appear to deeply understand the tenuous position they are in. They are certainly grabbing hold of the Widowmaker by the tail. They just want to cross their fingers and hope it doesn’t bite off a limb – an anxiety that highlights the dangerousness of their present approach. As these industry leaders continue to sail through this stormy waters, the line between fostering innovation and accepting risk is getting thinner by the day.
Even with these challenges, many economic indicators point to a surprising level of resilience from consumers. As the Conference Board put it, “we’re not just spending,” that strong consumer confidence seems to be persisting through the doom and gloom. This optimism is matched or overshadowed by the alarming predictions of analysts and economists.
“Yes, we see the iceberg. No, we don’t have lifeboats yet.” – Bloomberg and Reuters
This pronouncement highlights the harsh truth that lies before Japan as it continues to meet head on its dire fiscal challenges. The nation’s policymakers are dangerously close to the edge, unable to risk immediate economic stimulus against the potential long term harm to fiscal solvency. With the bond market still freaking out every time a policy change is announced Thursday’s big-swingin’ new PM Liz Truss, take a bow!
This action from the Ministry of Finance is a critical first step to address urgent liquidity needs. Importantly, at the same time, they are trying to increase confidence in Japan’s financial system. These strategies have big consequences. They produce a broader climate of unpredictability for investors and consumers alike.
As Japan’s policymakers take their axes to strategies that clearly aren’t working in order to respond to market pressures, the hard work only begins. That tricky balance between limiting debt accumulation and supporting robust economic development will take some deft hands and creative thinkers to strike.