[Update] Tremors in the Japanese bond market

Japan is "cooked"

Update 5/23/2025.

Overnight, the inflation report of Japan came out. The annual inflation rate remained steady at 3.6%, but the rate of core-inflation (excluding food and energy) accelerated to 3.5%, a two-year high.

I commented this on X by noting that “Japan is cooked.” Many probably did not understand what it was about :D, but it referred to this.

Source: MacroMicro.

The balance sheet of the Bank of Japan (BoJ) is rather “full.” The whole idea of quantitative easing (QE) was to expedite inflation by buying government bonds to make way for fiscal easing (i.e., spending). Well, this was not the publicly-stated aim, but a de facto one. Now, the BoJ got what they were looking for. The fact that core-inflation is picking up hints that the Japanese economy is facing increasing inflationary pressures. Summarization by Grok:

Japan's core inflation, which excludes volatile fresh food prices, hit a two-year high of 3.5% in April 2025, driven by several key factors:

1. Soaring Food Prices: Food costs, particularly rice, which surged 92.5% year-on-year in March 2025, have been a major driver. Global bad weather and higher imported food costs have kept food prices elevated, with rice alone significantly impacting the Consumer Price Index (CPI) due to its weight in the Japanese consumption basket.

2. Reduction in Government Subsidies: The phasing out of subsidies for electricity and gas bills has contributed to higher core inflation. These subsidies previously mitigated utility cost increases, and their reduction has led to a noticeable rise in household expenses.

3. Weak Yen and Import Costs: A weaker yen has increased the cost of imported goods, including fuel, raw materials, and food. This has been a persistent issue, amplifying inflationary pressure as Japan relies heavily on imports.

4. Rising Labor Costs and Wage Growth: Strong wage hikes, with Japan’s largest labor union securing a 5.46% increase in 2025, have prompted firms to pass on higher labor costs to consumers. This is particularly evident in the service sector, where prices rose 1.4% in March 2025, though goods prices (up 5.6%) remain the dominant driver.

5. Global Supply Chain and Commodity Pressures: Post-pandemic supply chain disruptions and global commodity price spikes, exacerbated by events like the Ukraine conflict, have sustained cost-push inflation. These pressures are particularly acute for energy and food imports.

Despite these factors, demand-driven inflation remains limited, with "core-core" inflation (excluding both food and energy) at 3.0% in April 2025, still below the headline core rate. The Bank of Japan (BOJ) views some of these pressures as transitory, but persistent food and import costs complicate its monetary policy, with concerns about U.S. tariffs adding uncertainty.

It is rather self-deceptive to argue inflation is “transitory” when it comes from increases in the price of food, which is difficult to fix short-term, and wage rises. The fact is that when inflation expectations get ‘anchored’ to a higher level, “transitory” turns quickly into “sticky,” implying that getting inflation down requires heavy measures because consumers and corporations start to expect higher inflation. This is exactly what has happened in Japan.

Source: Trading Economics.

Household inflation expectations have risen to a record (9.6% over the next five years). Moreover, supply-chain issues are likely to multiply, not to abate, because the geopolitical outlook in Ukraine and in the Middle East is not positive. The BoJ is in a bind.

How much support can the BoJ give to the Japanese bond market in this situation if the crisis deepens, which is likely (see below)? No one knows for sure, but a central bank should not allow inflation to get out of hand (should not). Enacting another round of QE fits the inflation outlook of Japan very badly, and cutting rates is next to impossible (the BoJ should actually start to raise rates more aggressively).

We are approaching an interesting hinge-point, where we see whom the central banks really serve: rulers or constituencies. I would start to (slowly) prepare for the unthinkable. That is, to defaults of governments of industrialized nations.

Tuomas

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Original, published on May 21.

Just learned from an X-post by Zerohedge that the Japanese bond market has been bidless for two consecutive days. For the second largest bond market in the world, this is rather alarming.

I and we at GnS Economics have also been critical of the Japanese economy for some time. On May 10 of last year, I commented on the currency crisis of Japan in The Land of the Ri... Setting Sun. The simple fact is that the Japanese economy has been ‘FUBAR’ for many years already. Her problems started from the bailout of the Japanese economy from the banking crisis of the early 1990s. From my piece: