Japan’s weakening yen could potentially cause a disruption in the global financial markets, according to market experts. The Bank of Japan and Ministry of Finance may need to intervene to prevent further decline in the yen and Japanese government debt. If these interventions lead to expectations of more aggressive monetary policy shifts, it could result in a significant increase in global government bond yields, which would dampen investor appetite for riskier assets. This concern was highlighted in late July when a small change in the Bank of Japan’s yield-curve control program caused a spike in U.S. Treasury yields and interrupted a stock-market rally. The fear is that rising Japanese yields would prompt Japanese investors to sell their U.S. Treasury holdings and invest domestically, causing a rise in U.S. and global yields.
The Bank of Japan’s policy tweak, which loosened the cap on the yield of the Japanese 10-year note, signaled a possible end to its ultra-loose monetary policy. However, the policy of yield-curve control currently keeps Japanese yields restrained. The concern lies in the tension between the BOJ’s interventions in the bond market and Japan’s fiscal position, which suggests that long-term borrowing costs should be higher. This situation resembles a game of tug of war, where the outcome can lead to significant spikes in cross-asset volatility. Furthermore, the rise in bond yields outside of Japan, triggered by the BOJ’s policy discussions, has also contributed to the weakening of the yen. As a result, investors are closely monitoring the exchange rate and the 10-year Japanese government bond, as they approach levels that previously prompted BOJ intervention.
Sleepy summer financial markets could get a rude awakening from Japan
As investors and market watchers continue to monitor China’s property-market woes, Japan is emerging as a potential source of volatility in global markets. The weakening Japanese yen is a cause for concern, with experts suggesting that the nation’s authorities may need to intervene to stop the slide. Stephen Gallo, global FX strategist at BMO Capital Markets, warns that if the yen continues to weaken and Japanese government debt remains weak, the Bank of Japan and Ministry of Finance may need to make "persistent or heavy" interventions. This could lead to expectations of more aggressive monetary policy shifts, which in turn could cause another jump in global government bond yields.
This potential jump in bond yields is worrying for investors, as it can dampen their appetite for stocks and other risky assets. In late July, a small change to the Bank of Japan’s yield-curve control program resulted in a spike in U.S. Treasury yields and put a halt to the U.S. stock market rally. The tweak, which further loosened a cap on the yield of the Japanese 10-year note, signaled that the BOJ is moving towards ending its ultra-loose monetary policy. Market watchers fear that rising Japanese yields would lead Japanese investors to sell their U.S. Treasury holdings and invest domestically, causing U.S. and global yields to rise.
However, at present, Japanese yields are still limited by the BOJ’s yield-curve control policy. The BOJ has stated that it will purchase 10-year Japanese government bonds at a yield of 1%, which is higher than the previous cap of 0.5%. The 10-year JGB yield is currently at 0.63%. This tug of war between the BOJ’s interventions and Japan’s fiscal position creates uncertainty and volatility in the market. Gallo warns that scenarios like these often end badly and can cause large upward spikes in cross-asset volatility.
The rise in bond yields outside of Japan, triggered by the BOJ’s policy rumblings, has also had an impact on the yen. The yen initially rose after the tweak to yield-curve control, but the bounce was short-lived. Traders are paying more attention to the still negative short-term interest rates rather than the minor adjustments made by the BOJ. As a result, the yen has weakened against the U.S. dollar, trading at more than 145 per dollar, its weakest level since November. Dollar bulls are cautious about pushing the dollar/yen pair above 145, as Japanese officials have shown signs of intervention. Japan’s Finance Minister has stated that he is closely monitoring the foreign exchange market and will take appropriate action if necessary.
The impact of these developments is already being felt in the U.S. stock market, with the Dow Jones Industrial Average down 0.4%, the S&P 500 down 0.6%, and the Nasdaq Composite down 1% on Wednesday. The recent weakness in stocks can be attributed, in part, to rising Treasury yields. Since the end of July, the S&P 500 has experienced a 3.9% pullback, the Dow has fallen 2.1%, and the Nasdaq has lost 5.9%.
In conclusion, while China’s property-market woes are a major concern, investors should also be wary of potential volatility stemming from Japan. The weakening yen and Japanese government debt could prompt the Bank of Japan and Ministry of Finance to intervene, which could lead to a jump in global government bond yields. This, in turn, could impact investor appetite for stocks and other risky assets. Additionally, the rise in bond yields outside of Japan has put pressure on the yen, which has weakened against the U.S. dollar. These factors have already had an impact on the U.S. stock market, with stocks experiencing a pullback in August. Investors should closely monitor these developments and be prepared for potential market turbulence.
