A possible crack on the Japanese Government Bonds

By Ichiro Suzuki In a week of heightened volatility on Wall Street, one noticeable movement in the financial markets was weakening of the Japanese yen.  After breaking 103 against USD on Monday morning, March 9, the JPY retreated for the rest of the week, softening slightly even on Thursday when the stock market suffered the second steepest fall after the Black Monday on October 19, 1987. (The Thursday’s fall relegated to the third place the next Monday.) It closed the week at 108.00. In the past, the JPY would have surged against the greenback in a week of massive selling. The week through March 13, has proved that the JPY is losing its long-held status as a safe haven currency. As interest rates around the world are zero lower bound (ZLB), the luster of JPY carry trades has receded significantly. It looks that JPY is no longer borrowed aggressively to fund investments in other currencies with higher yields. Until relatively recently, speculators borrowed in the JPY at zero or minimum interest rates and invested the proceeds in high yielding currencies for easy profits. In the old days, the Australian dollar (AUD) gave 7%. Since those days, spreads between JPY and others have narrowed considerably and are heading toward zero, reducing the attractiveness of borrowing in JPY. Amid the financial market’s volatility event, speculators close risk positions on carry trades, driving them to buy back the borrowed JPY in a rush, thus causing the currency’s hysterical surge. This didn’t happen in the week of March 9. JPY’s new behavior might have a long, strategic implications. Japan’s household sector has been notoriously risk-averse, holding onto low risk, low, zero to be specific, yielding assets such as bank deposits and the Japanese Government Bonds (JGBs). Their fears for risk assets have been long ingrained by the ever-rising JPY against the USD, ever since President Richard Nixon got the USD off the gold standard in the late summer of 1971, and thus setting the greenback to depreciate against the yen and European currencies (though not against the British pound.) The household sector’s primary concern has been avoiding losses at any cost, and cared little about returns risk asset might deliver. Since the summer of 1971, memories of foreign exchange losses have been sticking in their mind so persistently that foreign assets have been shunned most of the time, however much these assets might have returned. (The notable exception to their risk-aversion was an emerging market boom, or bubble, that preceded the global financial crisis of 2007-09. Japanese retail investors were fully subscribed to the dream of rising emerging economies, probably because its story was so easy to understand though the asset class failed to deliver promised returns.) If the JPY is stripped of the status of a safe haven asset and alleviates the fear of FX losses among average Japanese men on the street, they would begin to allocate more of their money into foreign risk assets. This change could spell a death knell to safe assets, notably the JGB. The household sector’s new asset allocation might let them buy more foreign assets at the expense of the JGB, denying further fall of JGB’s yields and eventually turning the yields around. This change could turn the Japanese financial world upside down, because everything is built on an assumption of ever-lower yields. About the author: Mr. Suzuki is a retired banking executive in Tokyo, Japan, who sits on several boards of universities.


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