Japan’s Warning For The US Economy

The Bank of Japan is anticipated to phase out its negative interest rates policy in the first half of 2024, marking the end of an experiment initiated in 2016. This development could exert a direct adverse influence on both the US economy and the global market.

In 2016, Japan, struggling with a deflationary environment, opted to reduce interest rates to stimulate consumer spending. Concurrently, the US was experiencing mounting inflation and opted for a gradual increase in interest rates. However, Japan not only lowered interest rates below zero but also entered negative territory, initiating the 'YCC' (Yield Curve Control) experiment. The assumptions were that by controlling its yield curve, the country may appear to be able to prevent recessions and artificially boost its economy.

The link between the Japanese economy and the global market hinges on the US's need to borrow money through the issuance of treasury bonds. Attracting buyers requires the US to maintain high-interest rates inflating further the cost of US debt.

Crucially, Japan is currently the largest buyer of US Treasury bonds. This is driven by the fact that, for Japanese investors, the return on Japanese Government Bonds at a 10-year maturity is less than 1%,while 10-year US Treasury Bonds presently offer almost 5%.

If Japanese central bank raises interest rates to remain competitive, it could discourage this significant buyer from investing in US treasury bonds. Furthermore, if the US maintains its borrowing and spending pace, it may need to further increase the interest rates to attract new foreign buyers, creating a self-perpetuating predicament which poses risks not only to the US market but also to the global economy.

Predicting the effects of such a situation is challenging, given the uncertainty around how much Japan might sell US bonds and increase its interest rates. Conversely, Japan, with the highest debt-to-GDP ratio among developed countries, might hesitate to raise interest rates due to the increased expense of servicing its debt.

In conclusion, the impending decisions by the Bank of Japan might significantly influence global financial dynamics, making it important for investors to closely monitor these developments.

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