(Bloomberg) -- The bond market’s economic canary in the coal mine looks poised to hit Japan.
The country’s benchmark 10-year yield is on track to fall below its two-year equivalent for the first time since the collapse of the Japanese economic bubble in 1991. Known as an inverted yield curve, longer-term yields below shorter ones are unusual in developed markets and often interpreted as a harbinger of recession.
The phenomenon is much talked about in the U.S. market, especially since the yield curve between 3-month and 10-year Treasuries inverted in March. Researchers at the Federal Reserve Bank of San Francisco have called it a “fairly accurate” recession predictor. While the Bank of Japan’s policy of yield curve control distorts market signals, the nation’s planned sales tax increase and the re-escalation of the U.S.-China trade war seem sufficient to hit growth.
Japan’s 10-year yield fell as much as 2.5 basis points to minus 0.20% on Monday, touching the bottom of the trading range tolerated by the BOJ. The two-year yield dropped 1.5 basis points to minus 0.22%.
“There is a great chance that the yield inversion between two-year and 10-year could occur anytime soon,” said Eiichiro Miura, general manager of the fixed income investment department at Nissay Asset Management Corp. in Tokyo. “Bond markets around the world are becoming more concerned about the fate of the global economy.”
While the BOJ is expected to be flexible about managing the 10-year yield, and could tolerate a fall below minus 0.2%, a rapid decline below minus 0.3% could lead them to send a signal to the market, Miura added.
The central bank could widen the 10-year range as one of the options for additional monetary easing if yields move a lot, Deputy Governor Masayoshi Amamiya told reporters on Thursday. BOJ Governor Haruhiko Kuroda said in June that it’s appropriate to view the target band flexibly.
The government is scheduled to increase the sales tax to 10% from 8% in October to ease the world’s biggest debt load and strengthen the social safety net. The effects of the scheduled consumption tax hike are projected to be smaller this time compared to the previous hike in 2014, Amamiya said. However, a decline in one leading indicator is already signaling economic weakness ahead.
Just a month before the tax increase in 2014, Kuroda had said Japan’s economy would continue its moderate recovery. It contracted 7.1% in the second quarter of that year.
(Updates bond yields in fourth paragraph.)
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