Japanese Rates Impact U.S. Bonds

The prospects for the Japanese economy continue to be encouraging. After suffering through a decade or so of deflation, current signs point to a reversal.

 The current yield on Japanese 10-year government bonds touched 2% in trading last Tuesday in Japan. The upward move was the first time yields were at 2% since August 1999. The rise in yields suggest a near-term increase in interest rates by the Bank of Japan and beginning a new trend of higher interest rates, which have also occurred in many other countries.

 But, I do not believe the Bank of Japan will increase interest rates just yet as it wants to make sure not to put a damper on the recovering economy and Japan’s renewed enthusiasm.

 The central bank had previously ended its super-easy monetary policy that had pegged interest rates at zero and has hinted at increasing rates. While a timeframe was not given, many pundits believe rates may begin to slowly rise later this year.

 The Nikkei 225 continues to trade near its five-year high on a rising trend line. The rise in the index reflects the steady improvement in corporate Japan.

 The reality is regardless of when Japanese interest rates rise, the trend is up. Higher Japanese rates may also hurt the flow the investable capital into higher-yielding U.S. bonds, which has been a favorite designation for Japanese capital during the past decade. The demand for U.S. bonds helped to support the U.S. dollar, but should Japanese interest rates rise to a point where they are attractive, we could very well see a decline in the flow of capital into U.S. bonds.

 This shift could pressure the U.S. dollar as Japanese investors would need to buy fewer U.S. dollars to buy U.S. bonds. The aftermath could put some pressure on the U.S. to increase interest rates on bonds to help attract investors and this would inevitably impact stocks.

 Just something to think about.