Could this trigger a stock market crash?

Dr James Fox takes a closer look at an alarming trend in the Far East that could have consequences for investors around the world.

Posted by Dr. James Fox

Published 17 July

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Japan’s bond market is making headlines again and it could have major implications for stock market investors worldwide.

Bond yields have surged to multi-year highs as the Bank of Japan (BOJ) winds down years of ultra-loose monetary policy.

Once known for rock-bottom yields, Japanese government bonds (JGBs) suddenly offer competitive returns.

As I write, here are the yields and changes (in basis points) in JGB. Rising yields indicates less demand for government debt and will mean government debt becomes more expensive to service.

Bond maturity	Yield (%)	Change (1 month, bp)	Change (1 year, bp)
2-year	0.79	+3.4	+47.7
5-year	1.09	+7.1	+52.3
10-year	1.59	+13.9	+56.8
20-year	2.63	+24.7	+77.5
30-year	3.17	+26.2	+100.5

Why should investors care?

So, why should investors in the UK care? Because the consequences of a Japanese debt crisis could be global. And that may hit stock markets right where it hurts.

For decades, Japan’s low rates powered the ‘yen carry trade’, fuelling equity rallies abroad — including in US tech stocks — as investors borrowed cheaply in yen and ploughed the proceeds into riskier, higher-yielding assets overseas.

But as Japanese yields spike, those investors may start repatriating huge sums back to Japan as the equation shifts. That could mean dramatic outflows from global stock markets, especially in areas most exposed to foreign capital.

What’s more, Japan’s debt burden is now exceptionally high, with its debt-to-GDP ratio above 260%, the highest in the developed world (although Japanese net debt is lower).

Confidence in the stability of Japanese government bonds is being tested and that could spread to other nations with increasingly unsustainable debt… like the UK.

If a crisis of confidence erupts, that could roil not only Japan’s economy but send shockwaves through equity markets globally.

Should investors panic? No. But it’s certainly a concern. Investors with heavy holdings in markets like the US or global tech should keep a watchful eye on Japanese bond developments.