How U.S. Subprime Fallout Affects Japanese Credit Markets

The Japanese credit market is a colossal local affair, and has traditionally performed independently of U.S. and European markets, reports PIMCO's Koyo Ozeki. However this trend has begun to reverse, and the implications of this could be significant for Japan:

Japanese corporate bond markets offer the cheapest means in the world at present for issuers to raise money, and we expect the volume of bond issuance to increase going forward, including a shift from stocks to bonds as the fund procurement method. This, along with the increasing popularity of samurai bonds by U.S. and European banks and Asian issuers, could cause the balance in corporate bond markets to swing from excessive demand to oversupply within the next six to twelve months.

Furthermore, the widening spread in global bank capital is raising fund procurement costs for Japanese banks. The banks are likely to toughen their lending standards, thus spurring an adjustment in lending rates and overall credit spreads. Given such developments as well as the change in supply and demand conditions, we believe that the groundwork is gradually being laid for a correction in the abnormally narrow spreads that have taken hold in recent years.

Furthermore, according to Ozeki, the fallout from the "subprime loan mayhem" will impact U.S. consumption, consequently hitting Japanese exports:

Earnings at export industries, the power behind the Japanese economy in the past several years, are slowing, and we believe that small businesses, which are already weakening, will experience even tougher conditions ahead. As such, we predict that Japanese corporate fundamentals, which have recovered sharply since 2003, will soon hit their peak, and the downside risks will increase gradually going forward.