Lessons from Japan
Early experience of ultralow rates now relevant to investors around world
In the early 2000s, global fund managers had to anticipate the every move of “Mrs. Watanabe” — a woman who did not exist.
The period between 2002 and 2006, when the Bank of Japan’s zero- interest rate policy began to feel like a permanent fixture, was the heyday for this notional archetype of a conservative Japanese householder, dabbling in international markets to plug the gap left by low salaries and paltry interest rates.
Other countries may soon produce their own legions of market- moving retail investors as ultra-loose monetary policy spreads more widely across advanced economies.
“When growth, inflation and interest rates are low, savers have a tendency to export their capital to economies that are growing,” said Bob Michele, chief investment officer at Jpmorgan Asset Management.
The International Monetary Fund warned in a report this week that, while warranted, “low for long” interest rates and the “truly staggering” level of central bank bond-buying could fuel dangers in the global financial system.
“The importance of central banks exercising their implicit ‘ put option’ cannot be overstated and has been a game- changer helping stabilize key markets. But such policies work in part because they encourage risk- taking,” the IMF noted. “As such, these central bank interventions may also have, if unintentionally, increased medium- term macro- financial vulnerabilities.”
The pandemic is the latest crisis to put downward pressure on global interest rates and bond yields, which have been trending lower for the past three decades. Today, most of Europe’s government bonds trade with negative yields and even the 10- year U. S. Treasury yield has fallen below 1 per cent.
Many market participants are still reluctant to believe yields are fixed on a downward path. “Most global investors I talk to aren’t quite ready to accept” ultralow rates as “the ultimate, inevitable outcome of the position we found ourselves in”, said Sheila Patel, chairman of Goldman Sachs Asset Management.
But the persistent decline in rates leaves households, corporations and institutional money contemplating the question of where to seek returns — much as their yield- hungry Japanese counterparts have done for decades.
For Japanese companies, one effect has been a sustained boom in overseas acquisitions and several years of record outbound M&A, making them early movers on prime assets in the U. S., U. K. and parts of Southeast Asia.
Another effect is capital flows: Japanese household investments have propelled at least two peaks in the yen carry trade — borrowing at low rates to invest in higher- yielding currencies or assets overseas. This has taken Mrs. Watanabe into the currencies of Brazil and Turkey and later to Australia.
The key question is the extent to which global capital flows could also be buffeted by a notional Frau Muller, Mme. Dubois or Signora Rossi. Or even, if ultralow rates become entrenched in the U. S., Ms. Johnson.
Some analysts argue that monetary and fiscal measures taken by policy- makers to counteract the effects of the pandemic could ensure the West follows Japan’s path.
Alberto Gallo, head of macro strategies at Algebris Investments, said the single most important issue for asset allocation over the next decade will be whether the world can escape “Japanification.”
“We are definitely on a Japanification path as monetary policy has been pulling most of the weight, and there are a lot of unintended consequences from low interest rates,” Gallo said. “There’s a trade- off between helping the economy in the short run, but at the same time preventing innovation in the long run.”
However he noted the U. S. could avoid the trend thanks to its more dynamic economy, younger demographics and scope for more aggressive government spending.
In Europe, the outlook is bleaker. “The current mix of falling Bund yields and rising ( euro) is indeed not healthy ( and) a sharp contrast to the reflationary dynamics observed in the U. S.,” Emmanuel Cau, head of European equity strategy at Barclays, said in a recent note.
“More policy support seems urgently needed, both at the monetary and fiscal levels.”
Currency traders in Japan said the emergence of a sustained euro, sterling or dollar carry trade would be a signal that Japanese investors’ search for yield is being replicated elsewhere.
Comatose fixed income markets would be another symptom. In a note last week, Morgan Stanley warned of the Japanification of bond market volatility as central banks try to cap even modest bursts of turbulence.
The explosion of day trading in the U. S. has parallels to Japan’s Mrs. Watanabe, but appears more powered by the stock market recovery, the emergence of game- like trading apps, stimulus cheques and lockdown boredom. Moreover U. S. bond yields, although low, do offer slender returns.
Some analysts argue that Japan’s experience does not offer a useful road map.
Hiroshi Ugai, an economist at Jpmorgan in Tokyo, noted one important difference between Japan’s experience and what might befall the rest of the world is that Mrs. Watanabe’s search for yield discovered plenty of relatively lower- risk options, notably in the U. S. and later Australia. That may not be the case now.
Ultimately, said Robin Brooks, chief economist at the Institute of International Finance, global markets “are unlikely to see those (capital flows) again”.
After the global financial crisis China’s massive stimulus created flows that raised commodity prices in emerging markets, but according to Brooks nothing comparable is happening today.
And interest rates in emerging markets have also fallen — and so they are unlikely to attract the same flows as they did a decade earlier, he said.