Japan's Bond Market Time Bomb: Could It Trigger a Global Financial Meltdown?

Raiders of the Lost Yield Curve

Right let's get down to brass tacks. Seems Japan's bond market is getting a bit… heated. According to some sources their long dated yields are playing peek a boo with record highs. Now I've faced down angry gods and mythical beasts but a bond yield curve? That sounds like a new kind of puzzle. Apparently demand for 40 year government bonds has taken a nosedive hitting levels not seen since last July. Trust me a tomb filled with cobwebs is more inviting at this point.

A Ticking Time Bomb?

One portfolio manager at Tidal Financial Group Michael Gayed thinks Japan looks like a 'ticking time bomb.' Confidence in their bonds is cratering and that could drag the whole global market down with it. I've seen ticking time bombs before – usually attached to booby traps in ancient temples – and they're never a good sign. Especially when someone like Albert Edwards strategist at Societe Generale Corporate & Investment Banking starts throwing around phrases like 'global financial market Armageddon.' Sounds delightful doesn't it? Just what I need after a long day of raiding tombs.

The Great Yen Escape

Macquarie's analysts are muttering about a 'trigger point' where Japanese investors suddenly decide to pack their bags and bring their capital back home from the US. Apparently higher yields and a stronger yen could dampen their enthusiasm for investing abroad. 'Investing in the US was as much currency gains as it was seeking superior interest rate returns,' someone said. In other words the allure of US tech stocks (which have seen large Japanese inflows) might be fading faster than a desert mirage.

Carry Trade Carnage

Ah the infamous carry trade. Borrowing in a low interest rate currency (like the yen) and investing in higher yielding assets abroad. It’s like finding a loophole in an ancient curse – tempting but bound to backfire. Last August things went sideways after the Bank of Japan raised interest rates. Some analysts are warning that this time the unwinding could be even worse calling it unsustainable for Japan's economy. The yen has already strengthened more than 8% since the start of the year. 'That could lead to a lot of traders unwinding those short yen positions and then you're looking at a potential repeat of last August,' a portfolio manager said.

Erosion Not Implosion?

Not everyone's convinced we're headed for a financial freefall. Some analysts believe the carry trade impact might be more of a gradual decline than a catastrophic implosion. One professor of finance at EDHEC Business School suggested a 'progressive erosion over a long period of time' due to the erosion in confidence in the US dollar. Personally I'd prefer a quick explosion – at least it's more exciting! I'm not sure what's worse waiting for a long time or being destroyed immediately... 'I make my own luck,' and my luck involves a little bit of both!

The US Japan Alliance: Unbreakable (For Now)

Apparently Japan's massive holdings of U.S. Treasuries are deeply rooted in the US Japan strategic alliance. One strategist believes there's 'little risk of divestment or 'dumping' of foreign bonds by Japanese investors.' Foreign holdings of U.S. assets are mostly concentrated in equities rather than Treasuries anyway. So even if things get dicey the outflow will probably start with equities and corporate bonds before they even touch those Treasuries. I feel like I am in a lost city! 'I'm not afraid of anything' but losing money!