Japanese government bonds – not a topic that normally fires up commentators and investors – are moving increasingly into the spotlight following – shock, horror – warnings about a possible credit rating downgrade to Japan’s sovereign debt.
Amid concerns about Japan’s rising levels of public spending and debt issuance, the JGB saga took a fresh twist on Tuesday as Fitch Ratings warned Tokyo to keep to its borrowing target or risk a credit rating downgrade. Adding to the debate, Hirohisa Fujii, the finance minister, acknowledged the problem and tried to reassure nervous investors by agreeing that public spending should be cut.
“Losing the confidence of the market would be damaging to our national interests”, he added.
Well, yes…
As Reuters reports, Japanese sovereign credit default swaps spreads have nearly doubled in the past week as investors fretted that the government faces a funding crunch over its ballooning public debt, which the IMF estimates will spiral to 227 per cent of GDP next year, by far the worst among G7 countries.
Yields on benchmark 10-year JGBs closed at 1.47 per cent on Tuesday, near their highest level for five months, after rising steadily in recent weeks. Even though, the FT notes, Japanese yields remain relatively low on a global basis — and below the levels of a decade ago, when yields rose from 0.77 per cent to 2.47 per cent in the space of five months – the market move in Japan could herald a wider shift in market sentiment towards sovereign debt at a time of massive government issuance around the world.
The rise in JGB yields is also creating an unwelcome headache for the new government in Tokyo, as Japan’s debt is so high that its servicing costs will rise sharply if JGBs move, by even a small amount, the report adds. Total Japanese government debt is close to 200 per cent of GDP.
According to Short View’s Jennifer Hughes, concerns that the Japanese government will have to borrow more than it has budgeted for next year are “hardly unique to Japan”. Indeed, she notes in a Tuesday column:
Governments around the world are sensitive just now because of their extra borrowing and the risks are rising that they too could face sharp jumps in the cost of those loans. Ideally, markets would adjust steadily and calmly to the fiscal situation as news emerged. But the likelihood is a far lumpier ride. Current low bond yields reflect many factors but one of those is some investor complacency about the economic outlook. This leaves markets wide open to the risk that any reaction to bad fiscal news is very sudden.But the “complacency” factor is one area where Japan differs markedly from some other countries. In fact, the ups and downs of economic policy under the new Hatoyama administration has investors clearly spooked.
Bond markets “have a history of savage sentiment changes which can send yields spiking higher”, says Hughes, reminding us of a famous example of such “bond vigilantism” which resonates today: the pain inflicted on the Clinton administration in 1994, as bond markets became nervous of rising inflation from the government’s economic stimulus efforts. Ten-year yields jumped 2.5 percentage points in 10 months, prompting James Carville, the Clinton strategist, to famously claim he would like to be reincarnated as the bond market: “Then you can intimidate everyone,” he said.
Concludes Hughes:
Japan is right to be concerned about the bond market’s unease. Other governments should take note too; episodes far worse are increasingly likely to erupt elsewhere — and they can be very expensive.
Related links:
Japan bonds gain the most since June – Bloomberg
Japan, Einhorn and ‘tontine’ fantasies – FT Alphaville
Japan’s sovereign debt crisis looms – FTfm
It is Japan we should be worrying about, not America – Daily Telegraph