Moody’s Downgrades Japan’s Credit Ratings, Stocks Rally

As proof that financial instability risk awareness have become mainstream, apparently a US credit ratings agency, Moody’s, decided to take action on Japan.

From the Bloomberg, (bold mine)

Moody’s Investors Service cut Japan’s credit rating, a setback to Prime Minister Shinzo Abe a day before today’s campaign start for an election that he wants to focus on the economy.

Moody’s reduced the rating for the world’s third-biggest economy one level to A1, the same as Bermuda, Israel, Oman and the Czech Republic, it said in a statement yesterday in Tokyo. The yen dropped to a seven-year low, then reversed the decline, while Japanese government bonds were little changed.

The ratings company cited uncertainty over whether Japan will achieve its deficit-reduction goals and succeed in boosting growth, two weeks after Abe postponed an increase in the nation’s sales tax. The Bank of Japan is buying record amounts of JGBs issued by a government that’s already burdened by the world’s heaviest public debt load.

Moody’s worried of Japanese government bond (JGB) market…

The cut by Moody’s was the first downgrade for Japan by one of the top-three ratings companies since Abe came to power in December 2012. Moody’s had rated the country in line with South Korea, Saudi Arabia and Taiwan before yesterday’s move.

There are increasing risks of a rise in bond yields that could make it harder for Japan to manage its debt, according to Moody’s, even as yields on 10-year government securities hover at less than 0.5 percent.

Most of Japan’s debt is owned by domestic investors, with foreigners holding 8.54 percent at the end June, according to the BOJ. The central bank became the biggest single creditor to the government for the first time on record in the first quarter.

The BOJ buys 8 trillion to 12 trillion yen ($101 billion) of Japanese government bonds per month, giving it room to absorb the 10 trillion yen in new bonds that the Ministry of Finance sells in the market each month.

Japan’s fantastic debt levels amidst record low rates exemplifies what I recently wrote “how financial markets have been entirely deformed from central bank policies”.

And part of such deformation has even been the emergence of NEGATIVE yields. 

Last Friday, some of JGB’s had produced negative yields for the “first time ever”

Why negative yields? The Wall Street Journal Real Time Economic blog explains (bold mine)

Japan’s negative rates stem largely from the BOJ’s massive bond-buying program aimed at lifting the nation out of deflation. After the bank’s move to expand its easing measures last month, the BOJ is now buying roughly the equivalent of all new debt issued by the government.

After the latest BOJ move, traders had expected the negative rate to come sooner rather than later, and were largely unfazed by Friday’s development.

Some traders said the normal functioning of the bond market didn’t appear to be among the central bank’s main objectives.

As the BOJ has put more priority on achieving its 2% inflation target than preserving market function and liquidity, “someone has to get the short end of the stick,” said Makoto Yamashita, chief Japan interest rate strategist at Deutsche Securities.

Others said the latest development shows the bank’s easing measures are hitting their limits.

“The negative rate indicates that the BOJ’s monetary easing is reaching a dead end,” said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance. “The market is drying up as the BOJ continues to snap up government bonds,” he added.

In short, JGBs are being sucked out of the markets. 

JGBs exhibit negative yields even today according to another Bloomberg report

For now this should be good news for the Japanese government because they have been financing their untenable debt levels with suppressed interest rates. 10 year yields continue to plumb to new lows. Today’s downgrade seems to only have marginally increased the yields.

The trouble will be in the future, particularly how banks and financial institutions will address on the system’s collateral issues.

Meanwhile the reported “BOJ is now buying roughly the equivalent of all new debt issued by the government” seem to validate my earlier suspicion that QE 2.0 has hardly been about boosting inflation but to ensure the financing of the fiscal deficits

Anticipating a recession, I wrote:

And speaking of recession, I believe that the BoJ’s has positioned itself to cover the added fiscal deficits from a possible economic downturn. This is what the BoJ’s QE 2.0 has been about. The 2% inflation rate target is just a camouflage.

With fiscal deficits expected to widen, where debt servicing is now equivalent to 25% of government budget and where the difference between taxes and social spending leaves Japan’s 2015 budget in a 7 trillion yen hole…all of which has been based on optimistic expectations, this leaves the BoJ as the only major source of financing for government or their JGBs.

So the BoJ may have expanded her QE to accommodate more monetization of fiscal deficits aside from possibly including the possible shift by GPIF out of domestic bonds. Of course the latter could function as a decoy as to shield the Japanese government from revealing its anxieties. Time will tell.

The Bloomberg article also says that changes in ratings have usually been ignored by the markets.

Investors routinely ignore ratings companies’ decisions. In almost half the instances, yields on government bonds fall when a rating action by Moody’s and Standard & Poor’s suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as the 1970s.

I’d suspect that this really depends on the conditions when changes are made. If changes in the ratings confirm the prevailing bias then they are likely to magnify the sentiment. But if the changes run contradictory to mainstream sentiment, then they are likely to be ignored.

The initial response by Japanese stocks has been a slight downside but seems to have reversed or seems back on the green.

This means “who cares about downgrades?”, stocks can only go higher!

With the kick off in the Parliamentary elections today, stock market punters will definitely go for Abe and his Frankenstein policy called “Abenomics”!