ROI-Japan faces unique oil, bond, FX triple whammy: McGeever
Oil prices are now above $100 a barrel. Bond yields and inflation expectation around the world have also risen. Japan is one of the few advanced economies that are suffering more than others.
Since the start of the war in Iran two months ago, there has been a steady increase in global sovereign bond sales. The 10-year gilt yield in Britain closed Tuesday above 5.00%, the highest since 2008. In Germany, the 10-year bund yield reached its highest level since 2011. And the 10-year Japanese Government Bond yield (JGB) this week matched the highest close since 1997.
Japan is unique in the G7 rich nation group when it comes to its vulnerability and exposure to global energy shocks. Around 95% of Japan's oil and 11% of its gas liquefied imports come from the Middle East, and around 70% and 6% respectively via the Strait of Hormuz.
Bank of Japan is in a wait-and-see mode, assessing which of two risks posed by the current crisis is more serious: a hit to growth or a spike in inflation.
Other countries are also facing stagflationary challenges, but Japan's challenge is made worse by the country's financial markets. The yield on the 10-year JGB is at its highest level in almost 30 years. Yet, the yen has fallen to a low of 40 years against the dollar. The yen is at its lowest level ever on a basis of "real effective exchange rates".
Keep It Real
To put it mildly, this complicates Bank of Japan's job. The BOJ policy meeting held on Tuesday perfectly summed up the dilemma. As expected, interest rates were held at 0.75%. The 6-3 vote was the largest number of dissents since a decade.
Officials have halved the GDP growth forecast for fiscal year 2010 to 0.5%, and increased their core inflation outlook by nearly a whole percentage point. Kazuo Ueda, the governor of the Bank of Japan, did his best in order to keep options open. He said that there was no predetermined idea as to how many months would be required before the conditions were met for another rate increase.
The hawks will be disappointed by this patience. Ueda, and perhaps others, may be hoping that the bond and rates markets will do the heavy lifting. This is beginning to happen.
Japan's benchmark 10-year bond yields have risen relative to the U.S. and UK since the beginning of the Iran War. After years of being negative, real Japanese yields and interest rates have now recovered.
For the first time in 2021, inflation-adjusted yields on 10-year JGBs are positive and higher than Germany. Japan's policy rate, adjusted for inflation, is now nearly equal to that of the eurozone.
It's raining Yen
Officials will worry and be frustrated by the yen
A negative loop is possible, in which high oil prices, coupled with a weak yen, fuel inflation and drive bond yields higher, while the exchange rate remains under pressure. This will intensify stagflationary factors.
In a certain way, the scenario has already begun to play out. Investors appear to be relatively relaxed so far. The Nikkei has risen 20% in the past year and reached a new high. Goldman Sachs says that this has eased financial conditions to their most relaxed level in 35-years.
The BOJ may have to act sooner than Governor Ueda wants if the energy crisis continues.
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(source: Reuters)
