Wan Ha (2:05)

The sudden selling in Japan's $7 trillion bond market sent tremors throughout global financial markets.

Ruth Carson (2:12)

While Treasuries join a global bond sell.

Michael McDermott (2:14)

Off as yields rattling higher, unsettling global fixed income markets. But it's not just fixed income, it's the dollar now as well. Today's big take looks at how a.

Wan Ha (2:21)

Week after the meltdown, Japan bond yields have settled somewhat. But Ruth says the bond market crash last week signals a turning point for Japan.

Ruth Carson (2:31)

You could always count on the Japanese bond markets to be stable. You could always count on the Japanese to be an anchor to global rates. But no longer. Interest rates are rising in Japan. The yen is so volatile it's ripping all the trading books apart. All of this is beyond volatility. It's a new regime for investing.

Wan Ha (2:54)

And if the chaos continues, there are risks the ripples will reach ordinary Americans and consumers around the world.

Ruth Carson (3:01)

This chaos is no longer a Japan problem, the chaos actually spread like wildfire into other markets. And that is why we are seeing authorities in the US and other places really starting to opine about these so called export shock Japan has to the world.

Wan Ha (3:34)

This is the big tech Asia. From Bloomberg News, I'm Wan Ha. Every week we take you inside some of the world's biggest and most powerful economies and the markets, tycoons and businesses that drive this ever shifting region. Today on the show, what's happening in Japan, Japan's bond market, who wins or loses in the fallout. Plus how ordinary Americans could be caught in the crosshairs. Before we get into what's happening in Japan's bond market, let's step back and look at how bond markets work. In general, governments like the US or Japan sell bonds to borrow money. Those bonds have a fixed timeline and a set rate, say 3% for 10 years. You buy the bond and the government pays pays you that 3% every single year. And once the 10 years are up, they pay you back your initial investment in full. Now when interest rates go up, the value of older bonds purchased at lower rates goes down. For decades, Japan's interest rates were around 0%. But in recent years, that started to change.

Ruth Carson (4:44)

If a particular central bank, in this case the bank of Japan, raises interest rates, suddenly your bond value drops. Because if the government sells more bonds at a current new rate, you'll get a higher yield, you get higher income. So why would you want to hold the bond that you had before you lose value on it? Imagine if you're, you know, putting money into a bank deposit and this bank promise you a 3% return on your safest investments, cash every single month. You know, you get a 3% annualized income from them. But hey, all of a sudden Bank B is saying, I'm going to give 4%. Most people would go, oh man, I'm out. I'm closing that account and I'm putting money into the one that's going to give me 4%.

Wan Ha (5:31)

Inflation has been rising in Japan since the pandemic. And in 2024, the bank of Japan hiked interest rates for the first time in 17 years. Since then, the country's central bank has moved four times to fight inflation, pushing rates to their highest level in 30 years. Ruth, walk us through the chaos of what happened on January 20, the day the Japanese bond sell off began. What was going through investors minds.

Ruth Carson (6:00)

Investors were already very nervous. In particular, there was already heightened tension around Japan because Prime Minister Sanae Takaichi had called for a snap election on February 8th. But there was also question marks around her fiscal stimulus. It was a cocktail of risks. It was a pressure cooker environment and something had to break. Then at around 12.30pm in Tokyo, an auction for 20 year bonds had come out. The results and the auction drew weaker demand than average. Another bad sign for some of the riskiest Japanese debt out there. So the longer maturity the debt, the riskier it is to buy. The second death knell, if I can call it that. So to put things into perspective, this is a $7 trillion plus bond market. It took only $280 million worth of trading to tip it into meltdown.

Wan Ha (7:00)

That's just a fraction of the market.

Ruth Carson (7:02)

Absolutely. So what does it tell you? It tells you that liquidity is so short in supply, or perhaps the traits are just so small that it took just a little bit to tip the whole market into chaos.

Wan Ha (7:17)

On that point, I just wondered if you can elaborate. I mean, if you invest in the markets, you're used to volatility, but why is any sign of volatility in the Japanese market so surprising to investors?

Ruth Carson (7:29)

So we go back to the idea of Japan being an anchor to the world. Remember that for years, decades, even Japan had incredibly low interest rates. It was so boring and stable that even the 10 year bond, which is often the most traded bond in any market in the world, there were days when there was no trading on 10 year bonds. That's how boring and tepid it was. And stable and stable. But no longer. We know that the epicenter is Japan of this risk because the BOJ is paring back its purchases of bonds. At the same time, you've got the life insurers in Japan, some of the biggest in the world, from what we're hearing in markets, down not buying as much as they did because they're waiting, they're waiting for rates to go up higher, for bond use to go up higher before they come in to buy. And so there is that soul searching across every trader out there in the world. It doesn't matter if you're in credit, stocks, bonds, currency, if you no longer have that backstop, what do you do? Now?

Wan Ha (8:41)

How did this meltdown impact the biggest stakeholders in Japan's bond market? You know, who were the winners and losers of what's happening.

Ruth Carson (8:48)

So far the percentage of Japanese owners of Japan government debt is very, very high. It's over 80%. So if you're a life insurer in Japan, for instance, and for years you've hoovered up all these bonds and they're now paying you a fraction in interest, you're sitting on a lot of losses. But the beauty about these insurers is that they can hold, they don't have to day trade, so to speak. There would have been money managers, you know, your traditional funds, big funds, foreign funds, who would have been playing in the JGB market. A lot of them would have taken a hit with the ferocity of the move. Some would have made a lot of money as well. Hedge funds for instance. If they had seen the dislocation, they might have bought, for example, when yields just skyrocketed because that means bonds were so cheap they would have gone, this is crazy, this is nuts. I've got a buck to make here. And they would have bought it at a top when it comes to the yield spike. And even if they sold it today, they wouldn't make money.

Wan Ha (9:48)

Now how is the government responding to this meltdown so far?

Ruth Carson (9:52)

Well, if I can be candid, there seems to be a shout out to markets to just calm your socks down. You know, we've seen the finance minister come out to say calm down guys, we're watching you. On the bond side, we saw the bank of Japan governor Kazuo Ueda actually saying that they will move to calm bonds. In other words, they will buy if needed to calm volatility because they know what's at stake here. It's no longer a Japan story, it's a world story.

Wan Ha (10:23)

And what about the reaction of governments around the world?

Ruth Carson (10:26)

It's been unprecedented to see, for instance, Scott Bessant coming out to speak about volatility in Japan. It's definitely gotten people worried. It is the topic of discussion across Asia, New York, London trading desks. How severe is this problem that even the US side is now getting involved? And importantly, remember, when it comes to currencies, it's never one sided, it's always two players at a game. It sends a very, very strong signal about how you position even on the dollar. So it's no longer a Japan problem.

Wan Ha (11:08)

Earlier this month, Japan's Prime Minister Sanae Takeichi surprised markets by calling a election and doubling down on plans for a massive stimulus package. What that means for Japan, a country in so much debt and what's at stake for everyone else, that's after the break. Trust is the lifeblood of a bond market. When investors trust a government and believe it can manage its debt responsibly, they lend it money cheaply. But when that trust falters, the dynamics shift. Investors start demanding higher rates of return, essentially more interest to offset what they believe is a greater risk that the country might not pay back its debt.

Ruth Carson (12:04)

It's a vote of confidence in Japan essentially that they are getting things very, very wrong on the policy side.

Wan Ha (12:10)

Still, Bloomberg's Ruth Carson says for Japan, the bond market crash last week wasn't just a financial event. It was a crack in investors trust. The Japanese government has relied heavily on borrowing for decades, trying to lift the country out of its so called lost decade of stagnation. But markets have grown increasingly skeptical about Japan's ability to manage its towering debt.

Ruth Carson (12:36)

Japan is the most indebted nation on earth in terms of developed markets. Debt to GDP over 200%. The fiscal situation, if you ask any bond investor out there, was tenuous to say the least.

Wan Ha (12:52)

And adding fuel to this fire is Japan's new Prime Minister. Sanae Takeichi.

Ruth Carson (12:57)

Takechi has come out to say we want to stimulate the economy. We want to make sure that growth continues. You know, the lost decades are truly behind us. We want to make sure that we task. And her policies on top of everything else are popular. Takaichi pledged to cut 8% taxes on food and non alcoholic beverages for two years.

Wan Ha (13:18)

That's roughly $32 billion in lost tax revenue, or about 6% of what the country collects in taxes annually.

Ruth Carson (13:27)

The problem was she didn't clarify how she would pay for it and that ticked investors off. So what does that mean? It means that the government is spending a lot more at a time when inflation is already running hot for years, mind you, above the BOJ's target. And remember that bond investors don't like inflation because it eats into their income. What they receive from the bonds, in this case JGBs.

Wan Ha (13:59)

It sounds like the fiscal situation in Japan has been really rocky. Now you've got Takechi calling for a snap election next month and the cut on food sales tax proposal too. What's the thinking on why she's doing this?

Ruth Carson (14:13)

So I think you need to unpack both on the political front and the economic front. She's winning votes, her popularity is high, people like it. They want more money in their bank account. Cost of living is so high, you want to address that in your pocket and worry about everything else later. The expectations are that she's actually going to entrench power. If you're going to entrench power, it's much harder to get rid of you. Even if markets you know are signaling they're not happy with your policies, you've got a people support and ultimately you're the leader of your country. Not bond markets.

Wan Ha (14:50)

Global investors are closely watching obviously how the Japanese bonds and the moves there are going to spill over into other markets. I wonder if you can just, just walk me through how global markets are impacted by this.

Ruth Carson (15:04)

Every time JGBS sell off, there's going to be waves, ripple effects, and then waves to other parts of the world. Remember that bond markets dictate borrowing costs for governments around the world through to even our own mortgages. The impact can be astronomical. Beyond the bond market, borrowing costs obviously impact the balance sheets of corporates, banks, miners, insurers, telecoms, AI companies. They need to borrow. And these people will be looking at their balance sheets going, goodness me, suddenly borrowing costs are going up a lot higher. That means I need to raise how much I will pay in yield, how much I will pay in income as well, to entice people to buy my debt. So suddenly they have to pay a lot more in interest too. So it starts like a small seed in some aspects, even though it's a $7 trillion market. But then it can quickly go into a forest fire very, very quickly and happen overnight, too.

Wan Ha (16:12)

But just because Japan's vulnerable to a forest fire doesn't mean it lacks the means to put out a blaze. The country may owe a lot at home, but Japanese investors like banks, pension funds and insurers are sitting on a massive pile of overseas assets, over $3.7 trillion at the end of 2024. That includes a lot of American government bonds.

Ruth Carson (16:38)

At what point do you, the Japanese, suddenly wake up and say, hold on, our markets are actually great. Yields have gone up enough now for us to just sell our overseas assets and money back home and invest in our own assets. Japan is the biggest holder of the U.S. treasury's market. From a foreign investor's perspective, with over a trillion, I think it's about 1.2 trillion that they have. Imagine if they sold a fraction of that. And I'm not suggesting that they do, but if a bit of that money came home, the snapback would be incredible. The yen would strengthen like crazy. JGBs would, you know, be in demand now.

Wan Ha (17:16)

It's been roughly a week since all of this started. Where are Japanese bonds yields this week?

Ruth Carson (17:23)

Things have calmed down a little bit, but if I can use the analogy of running a race, last week was Sprint. Everyone was running as fast as they could, as hard as they could to either minimize losses or make a profit. Yes, things have calmed down, but they are still running. So it's not a joke. People are still running on such tenterhooks as to what could happen next. They're ready with firepower if needed, whether to short Japanese government bonds or to buy Japanese government bonds. They're listening to the authorities. But the mood is far from calm. Everyone is still very much on edge. We still have the February 8 election coming up, so if you want to ask for a window as to when things could sort of pick up again, look anywhere from tomorrow through to the election. Take a pic because all it takes is a spark from just a matchstick. The embers are still there.

Wan Ha (18:38)

This is the Big Take Asia from Bloom. Welcome to Bloomberg News. I'm Juan Ha. To get more from the Big Take and unlimited access to all of bloomberg.com, subscribe today@bloomberg.com podcastoffer if you liked the episode, make sure to subscribe and review the bigtik Asia. Wherever you listen to podcasts, it really helps people find the show. Thanks for listening. See you next time.