Japan’s widow-maker bond trade still looks lethal
By Wayne Arnold
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
TOKYO — Bond traders have been betting against Japanese government debt for years — and losing spectacularly. Victims of the so-called “widow-maker” trade of shorting JGBs thought the March disaster would vindicate them. Rebuilding, after all, will add to Japan’s sky-high debt and, with a shrinking workforce and rising pension costs, push yields up. But the quake hasn’t disrupted the self-perpetuating money machine that drives JGBs. Doomsayers still run the risk of becoming road kill.
JGBs have outperformed U.S. and German bonds over the past five years, returning over 55 percent in dollar terms, according to Merrill Lynch, despite yielding less than 2 percent. Much of this is a function of the yen’s appreciation against the dollar. But short-sellers have also been flummoxed by the surprising way that a government with debt twice the size of its economy has managed not just to avoid a Greek-style blowout, but to borrow more cheaply every year.
All but 5 percent of JGBs are held by Japanese, not foreigners demanding attractive yields. Japanese who balked at low yields and invested elsewhere have been punished. At home, stocks have halved since 2005 and the yen’s climb has sapped gains offshore.
Japan’s pension funds accumulate long-term JGBs to match their liabilities. So, too, do insurers. Banks are the largest JGB buyers by far, a fact unlikely to change unless the economy revs up. With growth anemic and prices falling, companies are paying off loans and socking cash into bank accounts rather than investing it. With worthy borrowers scarce, banks park these deposits into JGBs.
Even if Japan’s economy does miraculously revive, inflation and growth would offset higher borrowing costs by boosting tax revenue. The real concern, then, is whether demographics might derail the JGB engine. As the workforce shrinks and the ranks of retirees grow, pension funds might need to sell JGBs. The government’s funding needs would then rise as income taxes decline.
Even without fiscal reforms, though, Japan isn’t likely to reach this tipping point for at least years — seemingly plenty of time to get its house in order, cut benefits, raise contributions and taxes to avert a crunch. True, Japan’s politicians — including Prime Minister Naoto Kan, who survived a no-confidence vote on Thursday — demonstrate a paucity of leadership to tackle these problems. But that’s still enough time to make a few more widows out of those betting against Japanese government debt.