To all - O.T. -- more Japanese macro-economic stuff. (Some of this is real boring, but some is worth looking at).
December 22, 1998
Japanese Bond-Market Crash
Threatens New Stimulus Plan
By ARRAN SCOTT and AUDREY MCAVOY
Dow Jones Newswires
TOKYO -- An astounding leap in Japanese government bond yields Tuesday sent the Tokyo stock market into a tailspin, threatened Japan's ability to carry out economic-stimulus measures and weighed on long-term U.S. Treasurys.
The yield on the benchmark 10-year Japanese government bond rocketed to 1.9%, the first time it hit that level since September 1997, from 1.505% on Monday on confirmation that the
Finance Ministry will stop its outright purchases of government bonds beginning in January 1999. That news followed an announcement Monday that the government plans to increase its bond issuance for fiscal 1999 in order to fund its massive fiscal-reform efforts.
The sheer speed of the move -- almost unimaginable in a developed economy
-- underlined how Japan's financial markets have stopped functioning normally
because of its severe recession and bad-debt problems.
"The economy is already in bad shape, and higher interest rates only make it
worse," said Brian Rose, economist at Warburg Dillon Read.
Analysts said that given the economy's weakness and falling product prices, it was by no means certain that yields would stay at their new levels. Some said the plunge in bond prices was overdone and that yields would soon ease somewhat as investors' panic subsided.
"Bonds are a buy at current levels from a fundamental perspective, looking at the condition of the economy," said Andrew Shipley, economist at Schroder Securities.
But some shell-shocked traders said the bond market still hadn't established a floor, and that it might therefore continue sliding through the end of January. "The market was completely destroyed today," said one trader.
The benchmark bond yield hit an all-time low of 0.64% in Tokyo on Sept. 18, the lowest level ever recorded in a developed economy in modern times. In recent weeks, it had been climbing as the government drafted stimulus plans that will mean a big expansion of its supply of bonds to the market; the yield has risen from 0.97% a month ago.
One catalyst for Tuesday's surge was the Finance Ministry's confirmation that its trust fund bureau, which had been buying about 200 billion yen worth of bonds a month, will stop these purchases in January, leaving the market to absorb those bonds. The bureau's funds will be diverted to economic-stimulus programs.
That suggested the government was caught in a dilemma -- it must issue more bonds to finance its fiscal stimulus efforts, but it no longer has the resources to stop the issues from pushing up long-term interest rates, which may undermine its efforts.
Earlier this month, for example, the government announced 1.2 trillion yen in tax breaks to stimulate housing investment next year, but the higher interest rates "more than offset those extra breaks," said Mr. Rose.
The Bank of Japan has been keeping money-market rates at record lows this year in an attempt to ease the pressure on crumbling corporate balance sheets.
If they are sustained for several months, higher bond yields may make a mockery of this policy, saddling companies with higher borrowing costs and forcing some into bankruptcy as the government absorbs capital, which
otherwise would have gone to the private sector.
"This is a classic case of crowding out. The government is running up huge amounts of debt and choking off private demand. We haven't seen it up till now, but it's finally happening," Mr. Rose said.
Construction companies and trading companies, because of their high level of borrowings, may be most at risk, analysts said. Banks also may suffer. More bankruptcies would swell their bad debts, while banks that benefited from the rally in bond prices earlier this year could lose a significant source of profits. Russell Jones, chief economist at Lehman Brothers Japan, estimated that a little over 25% of Japanese banks' profits in the half-year through Sept. 30 came from bond trading.
Higher bond yields "could cause a devastating margin squeeze," said Mr. Shipley. He had already estimated a 40% fall in profits at listed companies this fiscal year; an increase in the cost of capital, combined with the recent strengthening of the yen, could "crush profit," he said.
The surge in bond yields also suggested that the government was bumping up against the limits of its ability to use fiscal stimulus, even though public spending is now the biggest support for the economy.
Fiscal plans already announced are expected to push next fiscal year's initial budget deficit up to 9.2% of gross domestic product, a proportion that a Finance Ministry official said was worse than Brazil's. Higher bond yields could worsen this situation by raising debt-servicing costs and make any additional stimulus package next year very difficult to manage.
Because of such fears, the Nikkei stock average tumbled 373.50 points, or 2.6%, to 13779.45 points Tuesday. The yen fell against the dollar, to about 117.15 yen from 116.20 yen late Monday in New York. In normal times, rising yields would have been mildly positive for the yen, but the currency market focused on the dire implications for the economy, said Kazuo Takayama, chief foreign exchange sales manager at Midland Bank.
In New York, prices of longer-term U.S. Treasurys were lower again Tuesday morning, dragged down by mounting fears that the meltdown in Japan's government bond market may prompt Japanese investors to unload their U.S. Treasury holdings. However, thin trading conditions again prevailed in the Treasurys market. Midmorning, the yield on the 30-year Treasury bond was at 5.118%, up from 5.056% late Monday. The bond's price, which moves inversely to its yield, was down about 1 point, or $10 for each $1,000 in face value, 101 30/32. It dropped 30/32 Monday as stocks on Wall Street rallied.
Also spooking financial markets Tuesday was Japanese financial officials' apparent lack of concern about the bond-market meltdown.
Asked whether the ministry would take aggressive action to stop interest rates from rising, Finance Minister Kiichi Miyazawa said: "That kind of thing isn't planned." He said he didn't think there was enough corporate funding demand to push up interest rates for long.
Bank of Japan Governor Masaru Hayami appeared equally relaxed. "It's understandable that government bond yields are rising given the new bond issuances. But bond issuances are accompanied by growth in bank notes. This is not something to be too concerned about," he said.
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