Judging by the historic low yields on Japanese government bonds (JGBs), the deflation that has racked the country's economy for almost four years is set to continue indefinitely. In interest rate terms it seems more a question of 'how low can you go'?
Expectations of a sustainable recovery are clearly nowhere in sight: the yield on the benchmark 10-year JGB on Tuesday fell to an intra-day low of 0.775 per cent, a level last seen in October 1998. It was nearly three years ago that Japan overtook the US to win the dubious honour of being the world's leading issuer of debt. This year's budget, set to total Y36,450bn ($308bn), is to be 45 per cent financed by the issuance of new bonds. But despite concern regarding the sustainability of Japan's debt - set to total a staggering 150 per cent of gross domestic product this year - JGB yields have been skirting new lows for nearly 11 months. That underscores the voracious appetite of investors, particularly banks, for government debt despite the minuscule returns. Each successive dip in yields has merely been the precursor of another rally in prices as investors bet on deflationary pressures to continue in the near-term. But that may be a brave gamble considering that the governorship of the Bank of Japan will be up for grabs in March when the incumbent, Masaru Hayami, steps down amid debate as to whether the central bank should adopt an inflation target.
Japan's city banks increased their JGB holdings - most of which are shorter-term - by one-third from January last year to about Y43,000bn at the end of December, fuelled by a dearth of attractive investment options and a decline in loan demand. Ahead of the fiscal year-end in March, banks are due to unwind cross-shareholdings and further increase their JGB purchases, which now comprise about 10 per cent of their total assets. The adoption of an inflation target would probably result in a 25 basis point rise in both the two-year JGB yield, now close to zero, and in the five-year yield, which closed on Tuesday at a record low of 0.245 per cent, according to Mr Kato. "While the banks may be the greatest linchpin of the JGB market, they are also one of its greatest sources of instability due to their weak capital structures, poor operating results and overhang of non-performing loans," says John Richards, director at Barclays Capital in Tokyo.
Source: Financial Times