The HS Dent Financial Blog

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Is Japan Getting Closer to Meltdown?

Earlier this week, we wrote of the “Sinking Ship That Is Japan.”  Today, we’re going to take a look at what the bond market has to say about the Land of the Rising (or perhaps “Setting”?) Sun.

In an almost unfathomable vote of confidence in Japan’s credit worthiness given the county’s debt load and horrendous demographic picture, bond investors have priced the ten-year Japanese treasury at a yield of only 1.4%.  Investors are willing to accept a paltry return of less than a percent and a half from a borrower with the state finances of a banana republic — with government debt now closing in on 200% of GDP!

This prompts the question:  WHY?

The standard answer has been that,

1. Since Japan in experiencing deflation the real interest rate is higher, making the bonds more attractive, and
2. Japan’s domestic population, with its high savings rate, has a voracious appetite for “safe” fixed income, essentially willing to buy at any price.

Of course, for a lot of Japanese, the yield is not sufficient, and a fair number invest their savings in foreign stocks, bonds, and currencies.  They will almost certainly be happy that they did, as we view the likelihood of a full-blow currency crisis in the yen being very high within the next decade.

At any rate, international investors may not be as sanguine on Japan’s credit risk.   Consider the chart below, from Bloomberg.

This chart measures the price of “insurance” for the Japanese 10-year.  It’s the price chart of the credit default swap, measured in basis point.  Even ignoring the spike in the CDS price during the 2008 global meltdown, we can see that the price of insurance has been in an uptrend since early 2007.  Currently, it cost 70 basis points to insure the Japanese 10-year bond — or about half the current yield!

This chart is worth checking on every few months.  It’s just one more way to gauge the depth of Japan’s financial woes.  We would expect this chart to continue trending upwards…until Japan’s credit markets finally “blow up.”

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy