BOJ Foot Dragging Continues to Exert Upward Pressure on Japan's Bond Yields

The Japanese government has finally got around to lowering its 2009 GDP forecast from a prior 0% growth forecast to what is likely to be a minus 3% forecast. This after essentially all of the international agencies have downgraded Japan's GDP growth forecast from minus 5% to 6%-plus. This will mark the second year of negative GDP growth for Japan.

The Aso Administration had already announced a new JPY15 trillion stimulus plan that is aimed at boosting GDP growth by 2 percentage points. As the new forecast likely incorporates the boost to GDP from the new stimulus plan, the government was probably looking at minus 5% pre-stimulus plan.

The major issue for the JGB (Japanese government bond) market of course is just how the Japanese government intends to pay for this stimulus. The 2009 supplementary budget implies an additional JPY149.1 trillion of government bond issues, versus a prior budget of JPY132.3 trillion. The JPY149.1 trillion includes, a) JPY44.1 trillion of new revenue bond issuance (up JPY10.8 trillion from the prior 2009 budget), and fiscal investment and loan program bonds of JPY14.1 trillion (versus a prior JPY8.0 trillion), while bond issuance to refinance maturing bonds will ostensibly go from JPY9.0 trillion to zero.

The expanded issuance calendar effectively means that the Japanese government is now more dependent on bond issuance than tax revenues, and that any talk of a basic fiscal balance in the next few years is a pipe dream. This will virtually guarantee that total government debt will reach and exceed 200% of GDP in the next couple of years.

While all of the bond underwriters gathered by the government to hear their views on the issue increase reportedly agreed that the additional issuance can be absorbed in the market, the additional JGB supply forecast is pushing up Japanese interest rates, with the 30-year bond yield jumping from a January 2009 low of 1.75% to 2.25%. On the short end, the three-month Tokyo interbank offered rate, or Tibor, is declining because of the BOJ's flooding of the money markets with liquidity. Thus Japanese long rates are on the rise and the yield curve is steepening despite the deepest recession in the postwar period.

As we have pointed out previously, the prospect of substantially higher JGB supply is putting significant pressure on the Bank of Japan to use its balance sheet to expand its direct purchases of JGBs. At its meeting last month, the BOJ itself said that "substantial liquidity" was required to ensure stability in the financial markets, and decided to increase its outright purchases of Japanese government bonds by JPY4.8 trillion yen on an annual basis. The BOJ's monetary base is already rising at a 6.9% YoY pace, the fastest pace of expansion in nearly five years.

While the BOJ appears more than willing to provide as much liquidity as possible in money markets, they are much less willing to work with the government/GDP on financing the new stimulus package, i.e., the BOJ has no interest in the Fed/Treasury tag-team approach. BOJ governor Shirakawa continues to resist pressure to buy more JGBs, and as long as the BOJ continues to drag its feet on more direct purchases of JGBs, Japanese bond rates are likely to continue rising. In addition, with interest rates already back to ZIRP (zero interest rate policy) levels, the BOJ believes any further reduction in overnight lending rates would actually make money market trading unprofitable and stifle the flow of credit in the economy.

The BOJ is now talking about a recovery in Japan's economy in the second half of the year and slower declines in prices (shrinking deflation), ostensibly on evidence that there has been progress in getting domestic and overseas inventories under control, and of a slowing decline in exports--even though there remains "downside risk in corporate expected growth rates as well as global financial and economic conditions". This view is likely to be reflected in the BOJ's next "medium-term outlook for the economy and prices" due to be released on April 20.

If the BOJ really believes that the shrinkage in Japan's economy is slowing, they may be tempted to back off new policy initiatives and resist government pressure to use their balance sheet as a piggy bank even further, which is not likely to make the bond market vigilantes too happy.

Disclosure: no positions

Comments

[EMS News:]

The trap Japan fell into to deal with their massive stock/housing bubble was to turn banking on its head and run a ZIRP program for years and years. Few people noted that this has never, ever happened to a major export country in the entire history of banking and trade.

Even when inflation inside Japan was running well over 3%, the Bank of Japan kept interest rates barely above zero. The zero system didn't translate into widespread consumer spending inside Japan due to dropping wages. The drop in purchasing power was long and intense. Many Japanese lost regular jobs and had to go back to work at places like Toyota as 'part time workers' which made their economic situation even worse.

So Japan basically strangled its own domestic markets and made up for this via the Japanese carry trade business with hedge funds and domestic savers who made no profit on savings and of course, the immense export market.

Toyota, during the Japanese consumer depression, went on to become the world's #1 automaker while the US companies went bankrupt.

Japan's ZIRP system is like the one developing here in America: dropping wages coupled with much greater growth in government spending which requires low interest rates and which leads to a terrible system called 'Perpetual Debts'. These become more valuable, the lower the interest rate! You NEVER pay them off.

For more about this deadly financial trap of Perpetual Debts, go to emsnews.wordpress.com/.../ at Culture of Life News.

Apr 21 04:40 PM

[Mad Hedge F...:]

No problem for government borrowing here. Japan will soon hit its bond market with a near record $110 billion of new paper to finance its emergency economic stimulus program. Anticipation of the program has already pushed yields on the JGB to 1.46%, a high for the year, up from 1.21% in January. With short term interest rates at zero and the world’s lowest long bond yields, there is little doubt the government will pull this off, according to Sean Maloney, interest rate strategist at Nomura Securities. Nearly twenty years of weak domestic growth and a decently growing money supply have created a structural oversupply of capital in Japan, an endless cash glut, and a shortage of high grade, low risk investments. The bigger question is whether this splurge will make any difference. After building 1,000 “bridges to nowhere” during the nineties to cope with a “lost decade”, no country has more conclusively proven the futility of government stimulus spending on public works than Japan. Is Obama about to make the same mistakes in the US?

Apr 21 05:17 PM

[Reinko:]

I agree with the first comment:

The USA is heading towards a full decade long ZIRP system.

But the link posted at the end of the comment uses thousands and thousands of words and a lot of graphs that are not needed.

It's all pretty simple:

If average interest rates are about 5% and total debts inside an economy are 300% of the yearly gross domestic product, in that case 15% of the gross domestic product is needed to 'service the debt' (that means paying for the interest).

The USA has above 350% of debt on herself, so an average interest ratio of 5% would very soon lead to a complete and utter bankruptcy of the entire USA.

Simply because serving the interest is above the combined profits of the entire USA.

It is all so simple, why need thousands and thousands of words to arrive at this conclusion?????

Beats me...

As far as Japan is concerned, they have higher saving rates compared to the USA but their economy is not suited to survive when the USA finally defaults.
Poor poor Japs.

Apr 21 06:54 PM

[Darrel Whitten:]

Dear Reinko;

Just to set the record straight, savings rates in Japan are no longer higher than the US. US savings rate (as of Q4 2008) was over 3%, while Japan's has fallen to just above 2%, as the population rapidly ages and the number of "working poor" rapidly rises. Japanese salaries have fallen in seven of the past 10 years, unlike the OECD as a whole (25 countries), where average annual pay has risen consistently for nearly two decades, even during recessions.

As a result of the 90s Heisei Malaise, the Japanese government got all the debt, while corporations absorbed all the profit.

Apr 21 11:44 PM