A Sluggish Disaster Will Mark the End of Japan’s Negative Rates
There hasn’t been a period of 34 years when Japan’s stock market was this high. On Tuesday, the country’s central bank might make history by raising interest rates—the first time they’ve done so in 17 years.
Markets will not be abruptly transformed by higher and positive Japanese rates. The yield advantage of many U.S. assets could be further reduced if U.S. growth heads structurally lower for any reason, which could have severe repercussions in the long run. With its ultracheap yen, Japan has become the biggest foreign holder of U.S. Treasurys, a big overseas lender, and an export powerhouse whose corporate profits and stock prices have been greatly boosted. Everything from U.S. mortgages to infrastructure financing in poor nations might be affected by the eventual impact of more Japanese wealth staying at home.
Japan has maintained its ultralow interest-rate policy for the most of the last two years, swimming against the global monetary tides. The Bank of Japan, however, is ready to reverse course just as most of the world’s other leading central banks are preparing to lower interest rates. During its policy board meeting on Monday and Tuesday, the Japanese central bank is reportedly going to end its negative interest rates, which have been in effect since 2016. This news broke over the weekend in domestic media.
This move would be a response to years of flat wage growth and growing signs that the labor market is recovering. The first round of Japan’s annual spring wage negotiations concluded last week, with unions securing an average salary raise of 5.28%, according to the Japanese Trade Union Confederation. Over the whole ten years leading up to 2022, the cumulative yearly growth was never more than 2.4%.
Very unlikely to undergo a short-term transformation. In light of the Bank of Japan’s reputation for moving slowly and thoughtfully, the pace of rate hikes is likely to be slow. This reputation has been reinforced over the previous couple of years. Even while January’s inflation rate of 2.2% is high compared to other months in Japan, it has already dropped from last year’s highs.
Although Japanese bond yields have increased, they remain much lower than their American counterparts. There is a 3.5 percentage point spread between the yields on 10-year Japanese and American government bonds. While it is a considerable improvement from the 4.2 percentage point disparity that existed only a few months ago, it is still much larger than the 1.5 percentage point disparity that existed three years ago.
The yen will continue to be supported by a shrinking rate differential, particularly if the Federal Reserve decreases rates later this year, which is a distinct possibility. Optimism in the soaring Japanese stock market could be dampened by that. For overseas investors, who have been key figures in the boom, their purchase price would rise in dollar terms. Profits for some Japanese companies, particularly those involved in exporting, would take a hit if the yen were to strengthen.
The same holds true for Japan: even with slow interest rate hikes, investment flows are unlikely to be significantly affected in the near future. It may turn out differently in the future, though, if the return to positive rates can be sustained.
For many years, Japanese individuals and businesses have been heavy investors overseas, seeking better returns. The value of the country’s investments abroad reached $4.2 trillion by the end of last year. Japanese pension funds and insurers, who contribute significantly, would suddenly have better domestic options. For instance, the largest foreign owner of U.S. Treasury bonds is Japanese investors, who possess roughly $1.1 trillion worth of bonds.
For as long as most investors can remember, Japanese investors have been searching the world for better returns. Sooner or later, the consequences will be felt almost everywhere if that begins to shift.
