The waning Japanese government bond (JGB) market is facing a litmus test this month with a $16bn is...
The waning Japanese government bond (JGB) market is facing a litmus test this month with a $16bn issuance set to gauge demand for the asset class.
After a 14-year bull run yields have fallen so low fears are mounting that should the government have trouble unloading the five-year securities the market will face a further sell-off or even a meltdown.
William Pesek, an analyst at Bloomberg's Tokyo office, said 10-year rates fell to 0.43% last month leading to a sell-off, which pushed the yield up to 1.07%. Compared with the US Treasury's rate of 3.64% on 10-year dated paper, investors are still getting little reward for owning the asset class, however.
Japanese domestic investors have typically had few alternatives in which to invest though. Concerns about the dollar weakening have been deterring investors from putting money into US assets and until recently, the Japanese stock market yielded even less then JGBs and with far greater volatility and risk.
Ian Williams, head of fixed interest broking at Durlacher, notes some investors have started to switch into higher yielding equities after the average dividend on the Nikkei 225 reached 1.4% in April. This trend, which has not been seen in over 40 years triggered the recent sell off and if it continues, could have dire ramifications for global bond markets, he adds.
'The implications of this will hit markets worldwide, as Japan is both the world's largest creditor nation, while its government is the world's largest borrower,' Williams says.
'Because of its size and because Japanese investors are the biggest foreign owners of other nations' bonds, what happens in the JGB market has an all-powerful effect on other bond markets. It therefore follows that if the Japanese bond market were to collapse, as it appears to be doing, so too would the others.'
The Japanese government will make every effort to support the bond market, Pesek says, given that 96% of it is owned domestically. Moreover, public debt is the main asset class held by pension funds, insurance companies, banks and the postal savings system. As such, bond yield increases hurt much of the economy and could also severely damage the stock market as the value of these assets on the balance sheets of financial services companies plunges.
'The wide distribution of Japanese bond ownership also explains why owning Japanese bonds is a far safer bet these days than stocks. A plunge in shares may do less harm to the economy than a surge in bond yields,' Pesek says. 'Well aware of the bond market's pivotal role in the economy, the Bank of Japan will turn its full efforts to supporting bonds. Japan's notoriously fragile banks own more than a third of the JGB market. Anything that leads to a drop in JGB prices further impairs banks' balance sheets.'
In the near term, the Bank of Japan's stepped-up programme of buying JGBs should keep a lid on yields, Pesek believes, and the low incidence of foreign ownership is restricting capital flight to an extent.
But, longer term Tokyo may have to nationalise some banks and allow failing companies to go bankrupt, taking the resultant stock market falls on the chin in order to shore up the ailing JGB market, he adds.
Potential for Tokyo to nationalise banks.
This will allow failing firms to go bankrupt.
Low foreign ownership restricting capital flight.
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