Unconventional monetary policy and negative rates continue to bring unintended consequences. Globally, more and more sovereign bonds (over USD 10 trillion) now trade on negative yields with the 10 year German bund also joining the club. As negative rates and QE are being pursued policy outcomes are becoming less predictable than might have originally been hoped for. For example, currency moves are not necessarily as central banks predicted: take Japan, where the shift to negative rates earlier in the year was expected to help the currency weaken and boost growth and inflation. In fact the Yen has strengthened, exacerbated by the latest meeting, when the BoJ left policy unchanged and the Yen strengthened breaching the JPY105 level against the US dollar. At the time of writing the Yen is trading at ~104.28 to the US dollar; at the moment the market is not heeding attempts by government officials to ‘talk down’ the Yen. The Finance Minister, Taro Aso, called for global coordination to address these disorderly moves in the foreign exchange market.
Japan’s difficulties are also at risk of impacting its credit rating: on 13 June Fitch affirmed Japan’s long-term foreign rating at ‘A’ but revised the outlook to negative from stable. They note the government’s decision to delay the consumption tax increase has not been accompanied with by any offsetting measures thereby reducing Fitch’s confidence in the Japan’s plans for fiscal consolidation. The consumption tax hike was seen as an important driver in helping to bring the primary deficit of the central and local governments into balance in FY20. As a result, Fitch now expects its general gross government debt to GDP estimates to increase by 1-2 percent per annum out to 2024 from 245 percent at the end of 2016. But we note that while the public debt figures is high it is predominantly domestically financed (Japan has a positive net foreign asset (NFA) position). Offsetting these negatives, Fitch has marginally increased its growth estimates to 0.8 percent from 0.7 percent in 2016 and revised up its 2017 growth forecast to 0.7 percent.
BoJ policy has driven the yield on the 10 year JGB yield to -0.16% at the time of writing. Interestingly, Japanese investors have increased their purchases of overseas bonds buying USD 109.2bn year to date. US Treasuries have particularly been a notable recipient with inflows of USD 57.8bn year to date (30 April figure). Plus, Bank of Tokyo-Mitsubishi UFJ, one of the key primary dealers for JGBs, announced that it was looking to withdraw from this market: while primary dealers have certain privileges they are also required to bid on at least 4% of an issue but this role is perhaps less attractive when the large banks have been reducing their holdings in JGBs. That said, foreign investors have been net buyers of Japanese bonds in 19 out of 23 weeks this year!
For us, Japanese and foreign investors should look at the positive yield on creditor nations and quasi sovereign exposure in places such as the Middle East and Russia and selective Asian markets which still look amongst the most compelling opportunities in the fixed income markets.