The whole world is watching Japan right now … and for good reason.
Bond markets are something many everyday investors find complicated and, frankly, a bit boring. But for institutional and professional investors, they are anything but.
Bond markets act as the canary in the coal mine for the global economy and financial system.
It was the bond market that signalled the Global Financial Crisis even as sharemarkets were still booming.
So when Japan’s 30-year bond yield hit 3.41 per cent this week, many professional investors heard the canary singing.
Debt delusion?
Japan’s government debt is 230 per cent of its GDP (the size of its economy). It’s the most indebted nation in history. For decades Japan’s economy has survived because they have been borrowing at basically 0 per cent interest rates.
Not anymore.
Japan’s core inflation is running at 3 per cent, government bond yields are spiking to levels not seen since 1999, and it is now forced to spend 2 per cent of GDP on defense – that’s nearly 9 trillion yen annually.
The Bank of Japan has been faced with either raising rates and triggering a debt collapse, or keeping rates low and watching inflation destroy savings. They chose the latter.
Markets are reactive
Markets are reactiveSo, banks and fund managers around the world have been borrowing in Japan at 0 per cent interest rates and investing elsewhere – earning a much higher rate. It was a no brainer.
That was until borrowing rates started to rise … like they are now. When Japan’s system breaks, money moves. Fast.
Remember how the Nikkei dropped 12.4 per cent in a single day and the Nasdaq fell 13 per cent in July last year? This was all because of fears of rising Japanese interest rates.
Japan’s government pays interest on $9 trillion in debt, so every 0.5 per cent rise in rates costs an extra $45 billion a year. At current yields, interest payments will consume a massive 10 per cent of all tax revenue – that is huge.
The next Bank of Japan meeting is scheduled for 18-19 December, and markets are pricing in a 50/50 chance of another 0.25 per cent rate hike. If they do raise rates, expect markets to turn jittery. If they don’t, inflation will pick up again and the problem will worsen.
The ripple effects around the globe could be enormous.
