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Posted by: Deepa Vasudevan on Mon, May 27th, 2013

Volatility in the Japanese Government Bond Market

Japanese Government Bond yields have been very volatile in the recent weeks. In May 2013, the benchmark 10-year yield started at 0.59%, rose by over 15% in the second week, stabilized, then increased again to touch the psychological 1% mark, before finally settling at 0.85% levels. Why is the bond market not celebrating "Abenomics" that has been unleashed on the markets?


PM Shinzo Abe initiated after he assumed office in December 2012:


(i)   a massive 10 trillion yen fiscal stimulus (February 2013),

(ii)  doubling money supply through monthly bond purchases by the Central Bank (April 2013)

(iii) structural reform to boost private investment and exports (May 2013)


These measures are targeted at boosting growth and achieving 2% inflation by 2014. These measures are seen as Japan’s last ditch attempt at reviving an economy that has floundered and remained adamantly deflated for more than two decades.


There are indications that Abenomics is working: the Nikkei-225 index has gone up by 31% since January 2013, and GDP grew at an annualized 3.5% in the first quarter. A large yen devaluation has helped exports. Wages and bonuses are expected to rise; consumer spending is already rising. For the first time in two decades, inflationary expectations have moved up.


There is a conundrum in bond markets leading to volatile yields. A larger money supply and an aggressive buyback program should lead to falling rates and yields. But, if the target of the program is to take inflation to 2%, yields have to move up to match the expectations for inflation. The result is volatile yields and gyrating Yen. Markets may also be reacting to the inherent contradictions in what Japan is trying to achieve.


First, it is normal for bond yields to go up (and prices to decline) if inflation is expected to rise. But rising yields mean that bonds have to be valued at lower prices in balance sheets. As a result, domestic banks, for which government debt forms about a quarter of total assets, have been forced to increase provisioning for mark-to-market losses. This reduces their capital adequacy, and their ability to lend and support economic growth.


Second, Japanese government debt amounts to over 200% of its GDP (the corresponding number for India is 65%). As bond yields increase, rising interest liabilities would lower the debt servicing ability of the government, as well as reduce the fiscal surplus available for future spending.


A falling Yen may help Japan recover, while rising yields may dampen the flooding impact of the monetary stimulus and arrest the much sought after growth.  The question markets seem to ask is whether yields should fall in response to the stimulus, or rise in response to the increased risks. If the rise in yields persist, it would reduce the credibility of Abenomics and the positive sentiment that it has generated.

Sandeep Gandhi on Tue, May 28th, 2013 5:59:51 pm

A wonderful, simple and easily understandable article. Normally, we don't get the analysis of the foreign debt market. Very helpful. Keep updating and also update on Indian Debt market that how & why are the existing trends of the Indian Debt Market. Thanks,

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