BOJ, JGBs, AND CHINESE ZOMBIES
EDU DDA Jun. 13, 2025
Summary: With another possible oil spike lurking, you might think it would add to the JGB market’s wariness over the BoJ. After all, the detached irrationality of Bank of Japan policy is the sole reason why ultra-long JGB bonds have sold off and as much as they have. It isn’t fear over government debt, its inflation lunacy in Tokyo. And this is another one you don’t have to take my word for. Instead, the rest of the markets clearly understand higher oil adds to the growing goods economy payback we see emerging already in places like Canada, Britain, and Europe. If all that wasn’t enough for a Friday, Chinese banks and its zombie producers both fit right in to all the rest.
WHICH CRAZINESS BREAKS DOWN THE DOOR FIRST?
Japan’s 10-year bond rate dipped below 1.40% today on safe haven buying after the renewal of hostilities between Israel and Iran. Contrary to what perhaps most people have been led to believe, the yield for Japan’s 10s has been on a downward trend since the end of March. If you knew little other than media reports, you’d have been left with a very different impression.
According to those, bond vigilantes have finally been awoken in Japan like they have, reportedly, in the United States. LT bond rates are, they say, utterly soaring as demand for long-term government debt in these beleaguered locations has allegedly collapsed.
None of that is true, of course, starting with where the vast majority of interest rates are and have been trending. There is no denying both countries’ governments are the poster children for ineffective, reckless and unnecessary spending and “stimulus”, it simply does not matter as this week’s slate of Treasury auctions once again demonstrated.
The front part of the JGB curve is showing increasing caution about a variety of global factors, this week’s oil spike merely the latest one. As far as ultra-long Japanese debt where rates have actually jumped, those are just as easy to explain and it has nothing to do with deficits, either.
WAIT, WEREN’T THESE ‘FALLING OUT OF FAVOR?’
One of the macro negative factors the market has been waiting on to push rates even lower is payback. Tariff distortions created an artificial high all over the world (I may have mentioned this once or twice since it showed up last year), but pulling forward demand necessarily means it has to be paid back at some point to some unknown extent.
Both of those factors are really beginning to come into view, with updates across Canada, the UK and Europe.
Another key feature driving risk-off and monetary tightness (even “easy” money in Hong Kong) is China. The latest banking statistics for May drive home just how difficult the situation is there, particularly for its zombies. Without banks, there’s no growth, zero upside. And, another point proven, it does not matter what Beijing does.
Anyone remember that bazooka? The JGB market does and not in a good way. The whole curve would price that failure more aggressively if only for Kazuo Ueda’s windmill quest.
Short long JGBs
It’s really mid-March rather than late March when it began to turn around, even if technically the highest yield for Japan’s 10-year came on March 27. That day it very nearly punched 1.60%, still the most for it in forever. However, you can clearly see the inflection begin earlier in the month, around March 13 when the 10s first reached 1.549%.
That globally synchronized JGBs, to an extent, with others like Swiss bonds which might then seem to be trading a different world. Swiss rates are moving lower with more and increasingly negative rates whereas Japan is in the midst of a well-publicized multi-year “rout.”
As noted a few days ago, however, the Swiss to start 2025 were also retracing upward. If the market ever believed tariffs were inflationary, that was the time – certainly in Switzerland and, to a degree, in Japan. Each of them turned around the same time in March (or, for JGBs outside the very long end, began to turn around) as a very different view of risks began to prevail, before becoming the deflation and downturn.
But moving beyond JGB 10s, the reason for the upward bias out in those 30s and 40s is pretty easy and simple. It’s not fears over debts and deficits. After all, after this many decades, why now? Deficit hawks have always said there is some redline way out there governments dare not cross, yet they’ve been saying the same thing forever without any such repercussions.
What’s driving LT rates upward is nothing more than the Bank of Japan. Full stop. And this is another one of those times you don’t have to take my word for it.
Mizuho Financial Group Inc. is managing its securities portfolio “very conservatively” as Japan’s third-largest lender prepares for the next investing opportunity after shrinking its bond holdings.
The bank wouldn’t build up big positions until it is confident the Bank of Japan isn’t likely to raise rates any more, Chief Executive Officer Masahiro Kihara said during a question-and-answer session with the media on Tuesday.
Mizuho has cut its positions in foreign and Japanese government bonds, Kihara said. It slashed its JGB holdings to ¥8.3 trillion ($57 billion) as of March, from ¥25.1 trillion three years earlier, according to an investor presentation. While its foreign bond holdings rose from ¥8.9 trillion to ¥11.8 trillion over the same period, they dropped from a year earlier as the firm realized losses.
They’ve been radically reallocating away from JGBs since no one has any idea how far Ueda will push his irrational agenda. Given that the BoJ’s rate hikes are untethered from any sense of economic reality, there’s simply no way to predict when officials might finally regain some semblance of recognition, or what might be the reason for a return to more sanity.
Even now, with Japan on track for re-entering recession led by downtrodden household spending, Crazy-O Ueda keeps talking about the need for more rate hikes to keep a consumer binge from spiking inflation. No wonder Mizuho ducked out of JGBs; you can’t gameplan for fanaticism.
The same thought process applies in Japan as in steepening for Treasuries: the fundamentals flip to the short end more than the long end. Under bull steepening conditions, hold the shorter duration instruments and sell long on any uncertainty up to and including the BoJ. It was Ueda alone who created this selloff effect and how it has snowballed by introducing his unhinged policy expectations (more Odyssean forward guidance).
Therefore, quite understandably, the biggest Japanese financials have greatly pared back their JGB holdings and buying rather than accumulate more paper (not money) losses. And as that pressured JGB rates higher, more of Tokyo did the same leading to even higher rates, and so on.
The media will never blame any central bank for any mess, so it “must” be bond vigilantes.
No way.
Further up the curve, though, there is more of at least an intermittent fundamental drive. Rates there, for example, plunged last year during the carry trade debacle, meaning seeing past BoJ. And they did so again this year, even more, with worldwide deflationary conditions late March into early April. Though the 10s took another run at their March highs (yields) in May, it didn’t get there nor did it stick as JGBs have been trying to more synchronize back to Swiss or Treasuries in spite of BoJ rhetoric and intentions.
In fact, that’s the bet here, same as in Treasuries: the two places where central banks refuse to stop interfering in rates and introducing so much unnecessary uncertainty (to use their favorite term against them). Every other CB on the planet has seen the macro weakness and potential for more, having totally abandoned the “inflation” narrative to either keep racing to the bottom or rejoin that race.
At some point, that weakness overwhelms BoJ and FOMC “inflation” each’s interreference finally ends. For JGBs, once at that point, the 10s go lower and then buyers in Tokyo jump back in to the ultra-long maturities as Mizuho’s CEO blurted out.
Are we seeing that point developing now in JGBs? It’s possible with the 10s on their way back down already reaching 1.40%, where this week’s geopolitical disruptions are not helping. More than anything, though, any sustained rise in crude oil will almost certainly contribute a lot toward killing the “inflation” narrative, what’s left of it. We’ve seen crude spikes before and after a short run flick on a CPI they end up creating far more demand destruction than higher price behavior.
With that already underway from tariffs (companies absorbing costs) not to mention tariff-induced payback, even BoJ might be finally forced to rethink this time no matter how deranged its policy rationale up to this point.
Payback emerging
For the global services economy, fears over jobs and incomes, combined with whatever price changes do filter up, all of that has meant that part of the economic system has to take a big hit. Another oil jump would mean even more consumers (and businesses) having to pull from discretionary spending in order to pay for gasoline.
Over in the goods economy, it has been held up by the front-loading thus far. What does the overall economy look like, then, as services worldwide take more of that hit only to then have the goods sector now fall off under payback? It’s exactly the kind of potentially perfect storm which has shoved global policymakers off the inflation fence and back squarely in the camp of lower policy rates (not that those help).
One of the exceptions remaining on the same fence with Powell is the Bank of Canada. In fact, also discussed recently, BoC’s Tiff Macklem had the nerve recently to claim he had the Canadian soft landing in the bag before tariffs, even going so far as to say the artificial high in activity was actually evidence for this.
If it was (and it wasn’t), Tiff has bigtime explaining to do given the most recent data from the north.
Exports utterly crashed in April, according to the latest figures. Maybe a surprise to the BoC and the media, not to anyone else even remotely honest and aware of the situation. Outbound trade had soared to start the year and maintained a torrid pace through March, the timing leaving no doubt as to why…neither a soft landing or rate cuts.
Having surged to CDN73.4 billion by January, export values came down only a little in February and a little more in March. Maybe that was enough to give Macklem confidence payback wasn’t going to be enormous. Regardless, quite predictably April saw trade crash to just CDN60.4 billion, the lowest since June 2023, with likely more to come.
That meant exports jumped 17% to start this year over the beginning of last year, flipping now to being down 7% April 2025 from April 2024.
Payback has begun to appear in other ways, too. Canada’s imports fell off sharply for April, if not quite to the same degree as exports. Manufacturing and wholesale sales crashed, the former falling almost 3% in April alone, marking its biggest single-month setback since late 2023 and the second significantly monthly drop in a row (third straight overall).
The plunge in wholesale sales was also the largest in years, showing clear signs of payback, too, not soft landing.
Outside Canada, exports from the UK to the United States plummeted by the most on record, falling almost 9% also just in April. The director of the ONS stated, “After increasing for each of the four preceding months, April saw the largest monthly fall on record in goods exports to the United States with decreases seen across most types of goods, following the recent introduction of tariffs.” This set British exports to America back to February 2023 values.
Of course, the auto business led the way down, with lower vehicle trade to Europe also weighing on the economy.
In Europe itself, industrial production unsurprisingly (again, for anyone being honest) dropped by 2.4% also April after having risen by 2.4% in March when European producers, like their global counterparts, rushed to get goods manufactured before any duties could be imposed. Even though there has been a delay implementing the worst of them, it doesn’t matter since the goods economy in Canada, the UK, Europe, Japan and everywhere else was producing for demand that didn’t exist at the time.
Pulling forward necessarily means payback at some point; pulling forward as much as everyone did necessarily means a big hole in the goods economy. And with the spending climate everywhere weak to begin with, then possibly throw in yet another oil spike on top, the already-sizable hole gets to be at risk of being supersized moving forward into the summer.
Central bankers outside DC and Ottawa, maybe Tokyo, understand the gravity. It is only a matter of time and timing the rest come to see it, too.
Zombies emerge
Before ever getting to tariffs and payback, the Chinese have seen only a downtrend for years providing the backdrop for Japan and other trade and globally sensitive economies. In more recent times, it’s been the sharp drop-off in banking which has provided the additional drag while also opening non-trivial risks for a more severe backlash.
China’s banking system is nursing a credit crisis that has been building for a decade and more in the real economy. The real estate bust and its “contribution” is a more recent development (pun intended). Previous to it, banks had at least been able to participate in real economy credit so long as profitable property sector loans kept balance sheets afloat.
Without that outlet, the bad loans just piled up, forcing most banks into further de-risking. This leads to the downward spiral: de-risking banks create a credit crunch which drags the economy down more, pressuring weaker firms that need more debt to stay afloat at the same time convincing Chinese banks they can’t extend it to them or anyone else. The banks pull back more and so on.
GOING TO BE IMPOSSIBLE ABSENT BANK LOANS
The government in Beijing has been propping up the manufacturing economy for years, creating an army of zombie firms (something else in common with the inefficient Western post-2008 system) which are little more than an informal jobs program (MMTers are insanely jealous, even if it doesn’t work; the latter group can simply claim the Chinese “aren’t doing it right”) largely kept afloat by directed credit.
This is why China’s economy has been running on deflation for several years. Governments have prioritized jobs meaning running factories at higher rates, producing excess goods therefore constant discounting on prices.
The new reality has saddled China with the most loss-making industrial companies since 2001, the tail end of that earlier period of reform. Local leaders laden in debt are rolling out tax breaks and subsidies for companies, in a bid to stave off the double whammy of job and revenue losses.
That’s left President Xi Jinping’s government grappling with two conflicting goals: Avoiding mass unemployment that could trigger social unrest, while also closing enterprises churning out excess goods that are spurring deflation at home and a wave of anti-dumping tariffs from Europe to Latin America, and the US.
As Bloomberg also reports, one of China’s biggest online employment recruiters has suddenly stopped reporting on wage growth. What no one can hide even with widespread zombie jobs is falling demand for new work and new workers, the lack of hiring which plagues everyone everywhere in the forgot-how-to-grow environment.
Thus, like the US or anywhere, the economy is marked by no hiring as well as no firing, therefore also sowing confusion outside the marketplace. But for China, any firing depends greatly on bank funding and that’s an increasingly difficult proposition, accounting for the bank recapitalization plan meant to create balance sheet space among the biggest banks which might then allow the rest of the system to transfer all the bad debts and loans to them, freeing all the rest of the banks up again to make sure the zombie population doesn’t finally reach its limit.
It's actually a longshot since it takes a lot of time for even the largest bank cleanups to pay off, create space, and then have banks themselves begin re-risking. And given where Chinese banks are in terms of de-risking, that’s an even greater challenge to eventually overcome, and adding another layer of macro intrigue to the global background already swelling with more.
And that’s all before tariffs, payback, not to mention the latest potential oil spike and its demand destruction.
To say there’s a lot of risk coming from China is a wild understatement.
No, government deficits don’t matter. I wish they would in the market, they don’t simply because there remain too many other deflationary factors which depress growth expectations far more. Those are only occasionally counterbalanced by irrational central banking policies that chase inflation which doesn’t exist.
That was everyone in 2022 into 2023. Since, the Bank of Japan has stood largely alone, though the Fed a few others like Canada’s have revived their biases since then on tariffs (or last year’s “sticky” inflation which was neither sticky nor inflation).
Ironically, following a week in the US where the CPI and PPI both massively undercut the inflation case, it ends up with an oil price spike which threatens to deliver a positive CPI and PPI impact trade wars so far haven’t. But that only ups the macro downside, the inevitable deflation. Given the combination of worsening negative factors from demand destruction in services to goods economy payback, an oil spike won’t just depress spending further, it is just as like to push the US and other parts of the global economy further down the Beveridge Curve, too.
Go far enough in that flat direction, it stops even the Fed and BoJ. Weirdly enough, today’s oil action saw the market price a greater chance of that for the BoJ while less of one for the Fed. That’s how deeply embedded the latter’s expectations nonsense really is and how much everyone in the market knows it.
Meanwhile, the rest of the deflationary pieces keep falling into place, not that anyone needed the oil part of it.
