For around 20 years now, shorting Japanese government bonds has been the ultimate “widow-maker” trade. Might 2020 be the year the market finally cracks?
There are several reasons to worry that the world’s second-biggest debt arena is heading into a year of turbulence.
Since December 2012, Prime Minister Shinzo Abe’s stimulus efforts managed to produce the longest expansion since the 1980’s. To offset the jump in borrowing needed to finance countless fiscal-spending packages, Abe’s government has hiked sales taxes twice.
The first in 2014 boosted consumption levies from 5% to 8%. It triggered an immediate recession, necessitating even greater bond issuance.
At the start of 2014, Japan’s debt-to-gross-domestic product ratio was 232.5%. By the end of 2019, it’s seen topping 240% – on the way to 250%.
On December 5, Abe’s Cabinet announced a new stimulus jolt to offset the damage, a replay of 2014. It telegraphed a sizable shortfall in tax collections and larger bond auctions. As such, Japan’s fiscal health is unlikely to improve.
This fits with recent rumblings from the International Monetary Fund. Its economists worry a fast-aging and shrinking population is stymying Tokyo’s efforts to service a worsening debt burden. In 2018, Japan saw the lowest number of births since 1899.
Granted, the coming borrowing binge might not seem daunting for a $5 trillion economy.
At some point, though, bond investors will object to being party to the cycle in which Japan Inc. is trapped. Each pledge or effort to curb overall debt ends up falling short, only to be subsumed by the next one.
By the end of 2018, the Bank of Japan’s balance sheet exceeded the size of Japan’s entire economy. (Yes, you read that right.) And by April 2019, the BOJ became a top-10 shareholder in half of all Tokyo-listed companies.
That means the Bank of Japan is a bigger stockholder than even Japan’s Government Pension Investment Fund, the world’s largest.
For markets used to the monetary equivalent of a pyramid scheme, there’s no telling how punters might react when they realize the BOJ is unwilling to refill the proverbial punch-bowl.
As investors conclude that tax collection and BOJ largess has stalled, Japan’s safe-haven status is in jeopardy. Tokyo financial circles got a whiff of how that may play out on Oct. 1, the same day the latest sales tax hike when into effect.
That day, the Ministry of Finance sold US$20 billion worth of 10-year bonds. MOF officials figured demand would be robust given that Team Abe was reaffirming its commitment to fiscal consolidation.
In fact, the auction met the opposite fate. Demand, as gauged by the ratio of bids to the number of securities on offer, was the weakest since at least 2016. The result shook markets as far away as New York.
Still, Japan has two unique features going for it. One, nearly 90% of Japanese bonds are held domestically, reducing the odds of a global run on yen assets.
Two, they’re the core financial asset held by virtually every sector of the economy. If yields suddenly surge, local governments, banks, companies, pensions, insurers, endowments, universities and fast-growing ranks of retirees all get hurt.
This makes for a mutually-assured-destruction dynamic. It dis-incentivizes massive sales and incentivizes the BOJ to work closely with the Ministry of Finance to keep the peace in bond land.
Yet these unique features confront the secular trends mentioned earlier. Those are what Tokyo needs to address if it’s going to keep yields from skyrocketing in 2020.
Changing any one of these narratives is hard enough in the best of times, never mind amid a trade war and slowing global growth.
Given the low odds Abe can flip the script convincingly, Japan’s bond market is heading into a rocky 2020 – and taking a fragile world economy along for the ride.
Asia Times / ABC Flash Point Economy News 2019.