Why Japan’s Bond Market Could Make or Break Your 2023 Returns – Investment Watch

By Graham Summers, MBA

Japan’s central bank, the Bank of Japan, or BoJ, is starting to lose control of its economic system.

The BoJ is the grandfather of monetary insanity. The U.S.’s Federal Reserve (the Fed) first introduced Zero Interest Rate Policy (ZIRP) and Quantitative Easing (QE) in 2008.

The BoJ introduced them in 1999 and 2001, respectively.

Since that point, the BoJ has NEVER been in a position to normalize monetary policy. The longest it managed to tighten financial conditions without having to reverse and begin easing again was a measly 14 months.

So we’re talking about 20+ years of loose monetary policy or a slow-motion nationalization of Japan’s economic system. The BoJ has bought so many assets during this time that today it:

1) Owns greater than half (50%) of all Japan Government Bonds outstanding.

2) Owns more Japanese stocks than another entity (country or institution) on the planet.

3) Is a top 10 shareholder in 40% of Japan’s publicly listed firms.

4) Has a balance sheet that is the same as 92% of Japan’s GDP.

Having spent 17 odd years printing money and buying assets with little success in creating economic growth, in 2016, the BoJ attempted a brand new type of policy: Yield Curve Control (YCC).

In its simplest rendering, the BoJ stated that anytime the yields on Japanese Government Bonds rose above a certain level (0% for the 10-Yr Government Bonds), the BoJ would print recent money and use it to purchase bonds until the yields fell back to the specified range.

This was an open-ended, unlimited type of QE. And the BoJ maintained it for six years straight until inflation finally appeared within the economic system.

And that’s when things began to interrupt: the Yen collapsed to a 35 yr low.

At this point, the BoJ had a alternative: defend its currency or proceed defending its bonds.

The BoJ selected to defend the currency by RAISING the goal yield for 10-Yr Japanese Government Bonds from 0% to 0.5%. This was an implicit admission that it could print less money defending bonds. And it’s why the Yen began to rally in late 2022 (see the big bounce within the chart above).

Unfortunately, that’s the top of the excellent news. The bond market has begun testing the BoJ’s resolve, with the yields on Japanese Government Bonds rising above the BoJ’s goal repeatedly. Things have begun to spiral uncontrolled to the purpose that the BoJ is being forced to intervene on a near every day basis to try to stop the bond yields from soaring higher.

The BoJ is now in a corner. If it keeps printing money to defend bonds the Yen collapses making inflation worse. And if it doesn’t print money to defend bonds the bond yields soar and Japan becomes insolvent (unable to make debt payments).

As I keep stating, the Great Crisis… the one to which 2008 was a warm-up, has finally arrived. In 2008 entire banks went bust. In 2022, entire countries will achieve this.

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