Hideyuki Sao

TOKYO, Reuters – An unexpected spike in inflation expectations priced into Japanese bonds indicates that some investors have changed their long-held beliefs about Japan’s economy resisting any supply-side shocks.

A rising concern about global inflation, fueled by rising commodity prices, and a worldwide supply crunch, has prompted many investors to invest in Japanese inflation-linked bond, pushing the 10-year breakeven inflation(BEI) rate up last week.

Although investors seem to be confident in Bank of Japan’s ability to stabilize bond yields and the unexpected jump in inflation expectations from 2018 levels shows how pandemics are changing people’s perceptions of the country’s price pressures after decades of deflation.

Tadashi Mattsukawa from PineBridge Investments, Japan’s head of fixed-income investments, stated, “I believe there are many investors that are a little too careless about inflation. Thinking that it won’t happen here even though the rest of the globe is experiencing inflation.”

According to Matsukawa, consumers are no longer able to stomach price rises.

People haven’t been out drinking in so long. These people may be eagerer to buy it now. It is possible to be surprised if you assume that because deflation has continued for so many years, it will never stop.

Last week, the 10-year breakeven inflation rate (BEI), which is the difference between conventional and inflation-linked bonds, increased to 0.3%. This means that markets are expecting Japan to have an average of 10% inflation in the next 10 year.

This compares to an inflation expectation just 0.077% at mid-July, and about 0% by the end of last fiscal year.

Inflation levels that are higher than what the inflation rate is have been priced into bond markets since the end of 2020.

(GRAPHIC: Japan inflation – https://fingfx.thomsonreuters.com/gfx/mkt/egvbkmnmnpq/211008B.png)

Japan’s consumer price inflation is still low. The core CPI fell for one year, and then turned flat in August.

After removing two tax rises that had an impact on sales, the average inflation for the past decade was 0.1%.

Investors believe that the Bank of Japan will keep monetary stimulus going for the near future, despite the fact that inflation is not at or close to the Bank of Japan’s goal of 2%.

BOJ COUNTING

Market players agree with the assertion that Japan’s BEI Rate should be taken seriously. The small and inefficient Japanese bond market, which is linked to inflation, has limited traders and trading.

Also, the expected level of inflation is only a fraction of that which is baked into elsewhere — approximately 2.45% in America and 1.60% for Germany.

There are however some signs suggesting that prices are rising.

The hourly rate of contract workers increased 3.1% in August on an annual basis, which was the largest increase since December 2019. This is a sign that there may be a shortage of labour, according to data from En Japan.

(GRAPHIC: Japan wage – revised – https://fingfx.thomsonreuters.com/gfx/mkt/dwvkragldpm/211008E.png)

Although government data shows that wages increased 0.7% in August according to economists, the data may be misleading as an increase in low-paid jobs could impact overall wage growth.

Prices have been lowered by factors that used to help keep them in check. Chinese labor and the prices they charge are higher than ever.

Due to supply chain uncertainties and tensions between the U.S. and Japan, Japanese firms have been less likely to move production abroad.

The 10-year JGB yield rose four months to 0.085%, driven by inflation fears. Investors see little opportunity for an increase, but they are confident in the BOJ’s control and intent to maintain the yield at 0%.

If investors begin to question the BOJ’s commitment, there is risk of a surge in yields.

Hiroaki Hayashi (managing director, Fukoku Capital Management) stated that “without the BOJ’s policy peg the 10-year JGB yield might easily rise to 11%.”