Deutsche Bank warns of Japan capital flight in echo of UK crisis

Concerns over Takaichi’s spending plans have sent government bond yields to multi-decade highs and the yen has weakened to its lowest level since January

[LONDON] Sanae Takaichi’s spending plans have sent Japan’s bonds and currency tumbling, raising the spectre of an unruly capital flight reminiscent of the turmoil that nearly broke the UK bond market in 2022, according to Deutsche Bank’s global head of currency research.

Japanese government bonds are falling at the same time as the yen, reflecting concerns that the new prime minister’s stimulus plans, amid a dovish stance by the Bank of Japan (BOJ), will worsen the country’s fiscal health.

That’s worrying George Saravelos, who compared the correlated market moves with the 2022 UK crisis. At the time, the pound slumped to a 37-year low and the gilts market nearly collapsed after then Prime Minister Liz Truss’s unfunded tax-cut plans spooked investors.

It’s “concerning that both the yen and the long end of the Japanese government bond nominal market is starting to decouple from any measure of fair value and that intraday correlations are accelerating”, Saravelos said in e-mailed comments. “If domestic confidence in the government’s and BOJ’s commitment to low inflation is lost, the reasons to buy JGBs disappear, and more disruptive capital flight ensues.”

Concerns over Takaichi’s spending plans have sent government bond yields to multi-decade highs and the yen has weakened to its lowest level since January, slipping near a zone that could trigger intervention from the BOJ. The government is set to unveil the largest spending plan since the pandemic, according to documents seen by Bloomberg.

To be sure, the 2022 gilt market crisis was fuelled by forced selling from UK pension fund strategies. There’s no suggestion of a comparable risk from leveraged investors embedded into Japan’s market structure.

Still, Saravelos is not alone in expressing concern. Albert Edwards, a global strategist at Societe Generale, said the rise in Japanese long bond yields is “a major warning sign that very few investors are heeding”. The rate on 30-year bonds traded at over 3.35 per cent on Thursday (Nov 20), compared to about 3 per cent at the start of the month.

“It’s not a panic sell-off (yet), but an incremental, remorseless rise in yields,” Edwards wrote. “This secular bear market in government bonds, led by Japan, is destined to unwind the valuation inflation of the past 40 years in stocks and real estate.”

Saravelos said that while the BOJ and the government have so far seemed to tolerate the recent moves, he doubts they will be able to stay as quiet if the current price action continues.