RESEARCH CONTENT:
In the light of the recent Japanese downward inflation surprise, this note updates Japanese government and private sector debt data to determine if the Bank of Japan (BoJ) can really afford to tighten policy. In summary:
The large outstanding government debt continues to be significantly financed by the BoJ
Due to the preponderance of long dated bonds, the Ministry of Finance (MoF) is less exposed to interest rate rises than other Treasuries around the world.
A simple scenario analysis continues to show that rates have to remain low into the future (until there is debt debasement)
The recent decline in real household credit growth and deterioration in economic data raises the question as to whether the BoJ can/will tighten policy.
The front-end strip has hardly moved, despite the downward inflation surprise and weaker data. There is plenty of “surprise risk” here
The main driver to higher long-term yields in 2023 was higher inflation – disinflation could now be a tailwind towards lower yields. The steep curve also provides positive rolldown and carry.
A continued loose BoJ policy would mean further currency debasement and remove a cap on rising equity. However, equity returns remain (as always) at risk of extreme valuations and in foreign currency are likely to be less attractive, and are always at risk of BoJ officially removing ETF buying.
The lessons from Japanese debt and monetary dynamics are useful to other global economies, which in 2024 will themselves probably come to the end of their own second QE/QT cycle.
China is in a particularly tough spot following the fallout from Real Estate speculation that comes so close after the SOE bad debt episode. The PBOC and Government reaction in cutting rates and increasing spending, WITHOUT an expansion of the PBOC’s balance sheet, is straight out of the BoJ/MoF 1990-2011 playbook.
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