All monetary sins ultimately lead to the currency. There are no miracle exits for the BOJ.

By Wolf Richter for WOLF STREET.

The 10-year Japanese Government Bond yield rose to 3.02% today, the highest since August 1996, just about exactly 30 years ago.

But Japan’s bond market “rout” – and more broadly, the global bond market rout – isn’t so much of a rout, though rising yields mean falling bond prices, as it is the bond market slowly coming back to life after two decades of central-bank engineered financial repression that has led to numerous problems and distortions, including the worst inflation in four decades. And in Japan, on the forefront of this financial repression, it also led to the collapse of the yen.

From mid-2016 through mid-2021, the 10-year JGB yield traded at slightly negative yields to slightly positive yields, an absurdity that the Bank of Japan engineered with its Yield-Curve Control (YCC), which is a specific form of QE. But then reality hit: To deal with soaring inflation and the collapsing yen, the BOJ was forced to abandon YCC and QE and veer into the opposite direction: rate hikes and QT. This has allowed the Japanese bond market to rise from the grave. That’s what we’re looking at here.

Japan’s CPI inflation was at 1.9% in July, accelerating from June and May, after the plunge in energy costs had pushed it down earlier this year. In terms of July inflation, the “real” yield (yield minus inflation) of 10-year JGB maturities is only 1.1%. Last fall, with CPI inflation at 3.0%, the “real” 10-year JGB yield was still negative! So in those terms, the 10-year yield is still very low.

The 10-year yield is also low, considering the problematic fiscal situation of Japan, and its huge mountain of government debt, measuring roughly 248% of GDP (twice the US debt-to-GDP ratio).

Japan’s credit rating at Fitch (A) is five notches below AAA, and at S&P (A+) and Moody’s (A1) is four notches below (my cheat sheet of bond credit ratings by ratings agency).

So if anything, it’s amazing that the 10-year JGB yield is still this low. It should be substantially higher.

The reason it is still this low is that the BOJ still sits on a gigantic pile of JGBs, and its huge balance sheet still weighs heavily on the bond market though the BOJ has been doing QT for over two years:

The 30-year JGB yield dipped to 4.18% today after having risen to 4.19% yesterday, the highest since the 30-year bond was introduced in 1999.

This marks the completion of the seventh year of Japan’s bond bear market which started at the end of August 2019, when the 30-year yield bottomed out at +0.12% and the 10-year yield was negative -0.29% (by contrast, in the US the bond bear market, which started in late August 2020, just completed its sixth year).

Trying to halt the collapse of the yen.

YCC to contain long-term yields is now totally off the table as the collapse of the yen and inflation are forcing the BOJ to do the opposite: rate hikes and QT. All monetary sins lead to the currency. There is no miracle exit. What is needed to stabilize the yen is much more QT and substantially higher policy rates.

The USD/JPY exchange rate declined to ¥160 to $1 yesterday, and today rose a little to ¥159.

On July 31, a Friday, with the USD/JPY at ¥164, the US and Japan conducted a historic joint intervention, with the US selling an undisclosed amount of euros (not dollars) and buying yen; and with Japan selling a record $97 billion of USD for yen.

The collapse of the currency of the fourth-largest economy in the world is nothing to be trifled with.

The reason Bessent got the US involved in this intervention was to prevent the problems in Japan from bleeding over into the US Treasury market.

What would normally happen is that in preparation for the next intervention, Japan’s authorities would dump some Treasury holdings to get the USD cash, and then use that cash to buy yen. But Japan’s shedding US Treasuries was a factor in pushing up Treasury yields. With this joint intervention, Bessent tried to temporarily slow the rise of the Treasury yields. This succeeded temporarily, for a few days, but two weeks later, long-term Treasury yields were higher than they’d been before the joint intervention.

In terms of Japan, the collapse of the yen has led to the wrong kind of consumer price inflation, not nurtured by rapidly growing demand and salaries, but fueled by soaring import prices of fuels, foods, consumer products, components, supplies, and materials – despite massive government subsidies at the wholesale level to contain those effects – as it takes a lot more of these collapsed yen to buy the same products. It’s the collapse of the yen that the BOJ has been forced to react to.

 

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