By Tom Westbrook and Junko Fujita
SINGAPORE/TOKYO (Reuters) -Investors bailing out of the yen and Japan’s government bonds have driven borrowing costs there to record highs, bending markets out of shape and piling pressure on the country’s policymakers as they try to pilot the economy through a rough patch.
The selloff, which has also rattled stocks, has been unleashed by a lavish stimulus package – set to be the biggest since COVID-19 – that new Prime Minister Sanae Takaichi is expected to announce on Friday.
Her plans will mean yet more borrowing in a quadrillion-yen ($7 trillion) debt market that has been caught off-guard and which no longer enjoys a permanent bid from the central bank or Japan’s insurers.
With long-term government bonds down for 11 days in a row, the yen sliding for seven weeks and momentum seemingly building, the market is sounding the warning bells in an echo of the crisis of confidence for British assets that followed Liz Truss’s 2022 budget. The rout also narrows the options for policymakers – both in government and at the Bank of Japan – to stabilise things.
“Markets are saying louder and louder that the BOJ is risking falling behind the curve,” said Ales Koutny, head of international rates at Vanguard in London, who added that a more hawkish approach from the central bank was the only way to stabilise long bonds.
It is not just the BOJ under pressure, however. The selling has prompted concern from numerous officials, with Finance Minister Satsuki Katayama saying after an irregular meeting with the central bank that they were all watching markets with a “strong sense of urgency.”
That did not staunch the selling, however, which has pushed the yen to a 10-month low of 157.78 per dollar and 30-year and 40-year government bond yields to record highs. [JP/][FRX/][MKTS/GLOB]
The benchmark 10-year yield has shot up 11 basis points in four sessions to a 17-year high above 1.8%, and the volume in 10-year futures has jumped to a seven-month high.
“It’s basically the same conversation the market has been having about the UK for essentially the same reasons,” said James Athey, a fixed income portfolio manager at Marlborough in London.
“Central banks have spent the last few decades neutering price discovery, and politicians have grown accustomed to fiscal giveaways as the answer to everything. Conditions are now vastly different but the politicians just don’t want to learn. Take on markets at your peril.”
BUYERS STRIKE
Rising yields, a falling yen and a faltering stock market are an unusual and unsettling combination for Japan and reflect wobbly confidence and longer-run structural shifts.
A striking feature has been how the yen has departed from a usually tight relationship with U.S.-Japan interest rate differentials.
In the seven weeks since Takaichi won the party election that set her on the path to become Japan’s first female premier, the yen has lost about 6% against the dollar even as the 10-year U.S.-Japan rate gap has narrowed around 11 bps.
“You must either believe that there’s a ‘Sell Japan’ narrative going on, or you take the view that these relationships are no longer stable,” said Vishnu Varathan, head of Asia research at Mizuho in Singapore.
At the same time the BOJ is buying fewer and fewer bonds and Japan’s giant domestic life insurers are moving their portfolios away from longer-dated paper as their liabilities shift, leaving potentially flightier foreigners driving the price.
Insurers became net sellers of super-long bonds for a third straight month in October, which Mizuho said was the longest selling streak since 2004, to the tune of 276.7 billion yen.
Foreign investor buying also slowed sharply.
“You just don’t have many marginal buyers at the moment,” said Lei Zhu, head of Asian fixed income at Fidelity International in Hong Kong.
INSTABILITY RISING
All this leaves policymakers with a huge headache: Stimulus-funding costs for the government have shot up, while the BOJ faces an uncomfortable choice between picking up the pace of interest rate hikes – in the face of political pressure not to do so – or watching the yen slide further.
BOJ board member Junko Koeda told reporters on Thursday the bank was ready to step in if yields rise sharply.
But market participants see that as opening the door for more weakness, something the finance minister has said is starting to do more harm than good to the economy.
“It will require printing yen … to purchase the bonds. That will likely result in yen weakness,” said Nick Ferres, chief investment officer at Vantage Point Asset Management in Singapore, who had cut Japan investments to zero in January.
To be sure, there hasn’t been a wholesale exit from Japan.
Foreigners have been snapping up stocks, with October’s net inflow of 6.25 trillion yen the biggest in finance ministry data stretching back two decades. And until recently, the market was at record highs.
Positioning has also been a driver of the yen’s decline, as speculators have gradually unwound a record-sized bet that it would rise this year. Also, if Japanese yields rise far enough, buyers at home and abroad will step in to pick up the income.
But for now, nobody is in the mood. Sharp falls in the yen against higher-yielding currencies this week suggests a re-load of “carry” trades that profit while the yen is weak or falling and while Japan’s rates stay well below those of its global peers.
As one portfolio manager, who declined to be named as they were not authorised to speak with the media, put it: “I can’t find any reason to buy JGBs now.”
(Additional reporting by Gaurav Dogra in Bengaluru, Gregor Stuart Hunter and Rae Wee in Singapore and Rocky Swift in Tokyo; Writing by Tom Westbrook; Editing by Vidya Ranganathan and Hugh Lawson)
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