Japan’s deteriorating fiscal health adds more pressure to abandon YCC

With US long term treasury yields stabilising below 4% at the end of last week, global stock market breathed a sigh of relief while S&P staged a bounce on its key moving average support lines to finish the week in positive territory. However, with the yield curve remaining notably inverted, and there is a growing sense that the US central bank will likely raise rates more aggressively again this month to reign in on higher inflation rate, the mood is far from jubilant. 

In Japan, the stock market looks to be in a far better mood with overseas investors continuing to remain net buyers for now while Topix has advanced towards the upper band of its trading range of the past two years. This is partly helped by the weaker yen as the $¥ rate has risen from its January lows of 127 back to 135 level where most corporate earnings scenarios are based on. 

With BOJ’s incoming governor assuring markets that he is unlikely to change the central bank’s ultra-easy policy anytime soon, fears of stronger yen have receded for now. Indeed, the latest lead indicator of Japan’s inflation gauge, the Tokyo CPI for February grew by only 3.4% from January’s 4.4% as nearly ¥40trn of government subsidies for households kicked in last month with another ¥5trn cost reliefs targeting utility bills planned to be introduced by next week. 

To be sure, such stop-gap measures which make up nearly 40% of Japan’s fiscal 23 budget of almost ¥115trn look unlikely to be sustainable with Japan’s cumulative budget deficit now above 250% of GDP and cost of servicing that debt is now north of ¥25trn. This is especially given its fast-ageing population and shrinking labour pool which is raising social security costs to nearly ¥37trn, not to mention, plans to up its defence spending which is slated to rise by over 25% to nearly ¥7trn.  

All this means even more JGB issuance to fund the growing deficit. With BOJ owning over half of all Japan sovereign debt outstanding which is now above ¥1 quadrillion, the central bank will have to buy government bonds more aggressively to keep long term rates suppressed at current levels. None of this is sustainable and with inflationary pressures remaining high, the abandonment of BOJ’s yield curve control is only inevitable and soon.