Japanese government bond yields have slipped into negative territory close on the heels of the Bank of Japan’s (BOJ) imposition of negative interest rate on banks’ excess reserves. Japan became the first G7 nation to issue benchmark 10-year bonds with negative yields, essentially meaning the government is getting paid to borrow money. Outrageous!
The BOJ recently started charging lenders to holding some of their deposits (hoping to incent them to lend) instead of paying them interest. That move eventually pushed government bond yields below zero, first in shorter maturities and then for longer-term debt (10 year). The yield was -0.015% at point of sale. Even though Japan is the most heavily indebted amongst developed countries – with debt nearly two times annual GDP – it’s also considered safe by global investors and is highly rated, ‘on par’ so to speak with U.S. or European debt.
Global Woes and Domestic Difficulties Spook Investors into Bond Buying
The BOJ’s stance in penalizing excess reserves was likely intended to incentivize banks to lend, generating economic activity and driving up demand (which could help drive inflation, theoretically). However, in reality, that money has flocked to risk-free assets like Japanese government bonds as investors seem far too spooked by the unwinding of inflation and volatility in the global marketplace. With weakening oil and massive sell-offs of Asian stocks, investors are now viewing government bonds as providers of portfolio stability.
You could argue all day that government bonds offer safety and guarantee your principle will be returned at some point, but it still doesn’t sink-in that investors would be willing to pay to do this for 10 years. Where there is plausibility in the strategy, however, is the hope that investors can generate some capital gains should the bonds appreciate over time – providing a hedge against the (very low, in our view) possibility of long-term bearish equity markets. Many expect that further bond purchases by the BOJ will drive up bond prices, translating into capital appreciation for bondholders.
Most of these capital transactions apply to huge institutions, like banks and pension funds looking for slices of safety in a huge pie of assets. That makes sense. But, what about retail investors looking for sound, long-term investments? Buying into over-inflated bond markets should not be a logical choice. Instead, under-priced equities with strong balance sheets and sanguine prospects should be seen as the more optimal long-term choice.
Bottom Line for Investors
The frenzy over Japanese bonds and yen appreciation should not worry U.S. markets. In fact, the recent decline of the U.S. dollar against a basket of currencies, particularly the yen, might turn out to be a much-needed correction for an already strong greenback – it builds hope of the U.S. regaining competitiveness in the global goods & services markets. Additionally, even as U.S. equities look beaten down against rising Japan bond prices, investors seeking solid returns over time should continue to look for opportunistic bargain-buying of stocks based on fundamentals.
Disclosure