ROI-Japan faces unique oil, bond, FX triple whammy: McGeever

As oil climbs above $110 a barrel, bond ​yields and inflation expectations around the world are rising as well. Few advanced economies are feeling ​the pain more than Japan, and fewer still are as poorly equipped ‌to ​handle it. The global sovereign bond selloff has steadily gathered pace since the war in Iran began two months ago. Britain's 10-year gilt yield on Tuesday closed above 5.00% for the first time since 2008, the 10-year German bund yield has touched its highest level since 2011, and the 10-year Japanese Government Bond (JGB) yield this ‌week matched its highest close since 1997.

Japan's exposure and vulnerability to the global energy shock are unique among the G7 group of rich nations. It relies on the Middle East for around 95% of its oil supplies and 11% of its liquefied natural gas imports, with around 70% and 6% coming via the Strait of Hormuz, respectively. The Bank of Japan has been forced into a "wait-and-see" mode as it assesses which of the two risks ‌from the current crisis is greater: a growth hit or an inflation spike.

Policymakers in other countries also face stagflationary pressures, of course, but the challenge facing Japan's is exacerbated by the country's financial market backdrop. ‌The 10-year JGB yield is the highest in nearly 30 years, yet the yen is near a 40-year low against the dollar. On a "real effective exchange rate" basis, the yen has never been weaker. KEEP IT REAL

This complicates the Bank of Japan's task, to put it mildly. The BOJ's policy meeting on Tuesday encapsulated the dilemma perfectly. Interest rates were kept on hold at 0.75% as expected. The 6-3 vote marked the biggest number of dissents in a decade. Officials halved their GDP growth forecast for this fiscal year to 0.5% and ⁠raised their core ​inflation outlook by almost a full percentage point to 2.8%. ⁠Governor Kazuo Ueda did his best to keep the bank's options open, saying there is no "preset idea on how many months" would be needed before the right conditions for another rate hike are met.

This patience will disappoint the hawks. But perhaps Ueda and others ⁠are hoping the bond and rate markets do some of the heavy lifting for them. There are tentative signs this may be happening. Benchmark 10-year bond yields in Japan have risen more since the start of the Iran war in relative terms ​than in the U.S., UK or Germany. Meanwhile, after years of being deeply negative, real Japanese yields and interest rates are now rebounding.

The inflation-adjusted 10-year JGB yield is positive for the first time ⁠since 2021 and higher than Germany's. Japan's inflation-adjusted policy rate is now almost equal to the euro zone equivalent. IT'S RAINING YEN

The worry and frustration for officials will be that the yen hasn't gotten the memo. Rising yields and shrinking U.S.-Japanese spreads have failed to strengthen ⁠the ​exchange rate at all. So much so, the Ministry of Finance is still warning that it stands ready to intervene in the market at any time. The danger here is that a negative doom loop could take hold, where high oil prices and a low yen stoke inflation, pushing bond yields up further, but the exchange rate stays under pressure, causing stagflationary forces to intensify.

To some extent, it's a scenario that has already ⁠begun to tentatively play out. So far, though, investors appear relatively relaxed. The Nikkei is up 20% this year, hitting an all-time high. This has helped ease financial conditions to near their loosest level in 35 years, ⁠according to Goldman Sachs data. It's a delicate balancing act, ⁠though, and if the energy shock continues, the BOJ's hand may be forced sooner than Governor Ueda would like.

(The opinions expressed here are those of Jamie McGeever, a columnist for Reuters) Enjoying this column? Check out Reuters Open Interest (ROI), your essential new source for global financial commentary. Follow ROI on LinkedIn, and X.

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(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)