Japan’s Bond Crash Sent Shockwaves Through Global Markets

0:01Bloomberg Audio Studios Podcast Radio News Ruth, what's it been like for you this past week? If I can sum it up in one word, it's manic. Ruth Carson covers Asia's foreign exchange markets from Bloomberg. She says she was prepared for things to get a little busy Tuesday last week. You had Trump threatening fresh tariffs over Greenland. The U.S. was on holiday the day before. So the world's biggest provider for liquidity in bonds was out. So there was this tense, nervous air across all the trading desks in Asia. Now, that said, I thought things were under control enough by mid-morning on Tuesday for me to run out quickly to get some Singapore chicken rice across the street.

0:58I should have known. Of course, right. That was such a big risk. Absolutely. By the time she came back, the headlines started to roll in. Japan's super long bonds showed record selling by insurers. And picked up in quick succession. By 3pm, the volcano suddenly erupted. And my phone just started going ping, ping, ping, ping, ping, ping. JGB 30-year yields up 25 basis points. And that's what's now feeding into global bond markets. And now the yields here are up 20 basis points to its highest level since the 2000. The Japanese 40-year rate topped 4%, the highest level since its debut in 2007. It wasn't just the hot headlines.

1:45Investors were just going, oh my God, what just happened? The sudden selling in Japan's$7 trillion bond market sent tremors throughout global financial markets. While Treasuries join a global bond sell-off. Yields rattling higher, unsettling global fixed income markets. But it's not just fixed income. It's the dollar now as well. A week after the meltdown, Japan bond yields have settled somewhat. But Ruth says the bond market crashed last week signals a turning point for Japan. 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.

2:23But 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. And if the chaos continues, there are risks the ripples will reach ordinary Americans and consumers around the world. 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 the so-called export shock Japan has to the world.

3:18This is The Big Take 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's bond market? Who wins or loses in the fallout? Plus, how ordinary Americans could be caught in the crosshairs.

3:49Before 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 U.S. 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 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.

4:28If 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 % annualised income from them. But hey, all of a sudden, Bank B is saying, I'm going to give you 4%. Most people would go, oh man, I'm out.

5:12I'm closing that account and I'm putting money into the one that's going to give me 4%. 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 20th, the day the Japanese bond sell-off began. What was going through investors' minds? Investors were already very nervous. In particular, there was already heightened tension around Japan because Prime Minister Sanae Takeuchi had called for a snap election on February 8th, But there was also question marks around her fiscal stimulus.

6:03It was a cocktail of risks. It was a pressure cooker environment and something had to break. Then at around 12.30 p.m. 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 to debt, the riskier it is to buy. The second death knell, if I can call it that. So to put things to perspective, this is a$7 trillion plus bond market. It took only$280 million worth of trading to tip it into meltdown. That's just a fraction of the market. Absolutely. So what does it tell you?

6:49It tells you that liquidity is so short in supply. Or perhaps the trades are just so small that it took just a little bit to tip the whole market into chaos. 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? 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.

7:40That'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, they're not buying as much as they did. Because they're waiting, they're waiting for rates to go up higher, for bond yields 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.

8:21If you no longer have that backstop, what do you do? Now, how did this meltdown impact the biggest stakeholders in Japan's bond market? You know, who are the winners and losers of what's happening 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.

9:09a 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 the top when it comes to the yield spike. And even if they sold it today, they wouldn't make money. Now, how is the government responding to this meltdown so far? Well, if I can be can, it. There seems to be a shout out to markets to just calm your socks down.

9:45You 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. And what about the reaction of governments around the world? It's been unprecedented to see, for instance, Scott Macent 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.

10:29How 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.

10:53Earlier this month, Japan's Prime Minister Sanai Takeichi surprised markets by calling a snap 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.

11:24Trust 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. It's a vote of confidence in Japan, essentially, that they are getting things very, very wrong on the policy side still. Bloomberg's Ruth Carson says for Japan, the bond market crashed last week. wasn't just a financial event. It was a crack in investors' trust.

12:05The 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. Japan is the most indebted nation on earth in terms of developed markets. Debt GDP over 200%. The fiscal situation, if you ask any bond investor out there, was tenuous, to say the least. And adding fuel to this fire is Japan's new Prime Minister, Sanai Takeichi. Takeichi has come out to say, we want to stimulate the economy. We want to make sure that growth continues.

12:49The lost decades are truly behind us. We want to make sure that we target that. And her policies, on top of everything else, are popular. Takeuchi pledged to cut 8 % taxes on food and non-alcoholic beverages for two years. That's roughly$32 billion in lost tax revenue, or about 6 % of what the country collects in taxes annually. 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 BRJ'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.

13:44It 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? 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 are signaling they're not happy with your policies.

14:30You've got a people support, and ultimately you're the leader of your country, not bond markets. 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 walk me through how global markets are impacted by this. Every time JGB 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.

15:16Banks, 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. But just because Japan's vulnerable to a forest fire doesn't mean it lacks the means to put out a blaze.

16:04The 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. 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 bring the 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.

16:46Imagine 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 be in demand. Now, it's been roughly a week since all of this started. Where are Japanese bonds yields this week? Things have calmed down a little bit. But if I can use the analogy of running a race, last week was a sprint. Everyone was running as fast as they could, as hard as they could to either minimise losses or make a profit. Yes, things have calmed down, but they are still running. So it's not a jog.

17:31People are still 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 8th 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.

18:23This is The Big Take Asia from Bloomberg News. I'm Wan Ha. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you liked the episode, make sure to subscribe and review The Big Take Asia wherever you listen to podcasts. It really helps people find the show. Thanks for listening. See you next time.