A love of all things Japanese influenced 19th-century European culture, as reflected in Impressionism and The Mikado, a light opera. Japonisme is now abroad in European financial markets instead. Japan used to have the lowest yielding debt in the world. But 10-year yields on German, French and Nordic sovereign bonds have dropped below those of Japan government bonds (JGBs). Soon it may be the turn of UK gilts, whose 10-year yields are set to fall below those for JGBs.
Over the past two decades short sellers have tried to attack the JGB market, expecting yields to rise there. A combination of zero interest rates, incipient inflation and a bloated central bank balance sheet would force bond prices down, they figured. At the end of 2019, gross debt to gross domestic product was an extraordinary 230 per cent according to Fitch. But the collapse in bonds never came. Shorting JGBs won the moniker “widow-maker”.
Instead, bond markets elsewhere have followed trendy Japan. Long-term yields have collapsed to zero, or below. Coronavirus has crushed the life out of most world economies, including the UK. A collapse in output coupled with central bank intervention has swelled the Bank of England’s balance sheet. As of May, the UK debt-to-GDP ratio had jumped above 100 per cent, from about 85 per cent at the end of 2018. The spread between nominal 10-year gilt yields and equivalent JGBs has halved to about 18 basis points since March.
Even that tiny spread should disappear soon. Job losses in the UK are mounting. The Financial Times estimates that 100,000 job cuts have been announced by larger companies in Britain since the start of the pandemic. That is bad news for society but good news for gilt bulls, who hope low rates will continue. Meanwhile, implied UK long-term inflation rates, using index-linked gilts, remain higher in Britain than in most of Europe. The two have fallen sharply this year.
Chic Japanese minimalism will remain a feature of European bond markets for the foreseeable future. Expect long gilt yields to slip below JGBs some time after the summer.
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