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The Bank of Japan’s tricky path to normalisation
For market watchers, the prospect of Japan’s interest rates rising into positive territory became more unnerving with each passing year. The longer borrowing costs remained below zero, the more traders and investors — at home and abroad — became accustomed to it. A reversal of that status quo risked upsetting financial stability. But on Tuesday, after eight years in the negative, the Bank of Japan governor Kazuo Ueda pulled it off in smooth style. He raised rates from -0.1 per cent, to a range of 0 to 0.1 per cent, and called time on yield curve control. Global markets took it all in their stride.
That is down to the BoJ’s prudent choreography. It gradually loosened its approach to YCC in prior meetings to avoid abrupt market moves. Its decision was well signalled, allowing traders time to price it in. The central bank also decided to continue buying Japanese government bonds and made clear that rates would not march higher any time soon.
Outright tightening still seems far off. Most analysts do not expect recent wage growth to be maintained, and near-term inflationary momentum has waned. The BoJ nonetheless needs to continue to tread carefully. Markets will want to decipher the central bank’s plan for normalisation, so its next steps take on even greater importance. Financial exposures, forged during the BoJ’s ultra-loose era, have not gone away.
First, in the hunt for better than near-zero returns at home, Japanese institutions, including pension funds, life insurance companies and banks, have become major international investors. International portfolio investments were over $4tn at the end of 2023. Japan is the largest foreign holder of US government debt. Higher yields back home could tempt Japanese investors to retrench, reducing demand for US and European government debt in the process. Higher hedging costs have already prompted some to do so. The yen has also been the funding currency for carry trades, where investors borrow in low-cost yen and swap it for higher-yielding dollars.
The second source of risk comes from Japan’s public finances. At around 2.5 times the size of its economy, Japan’s debt is vulnerable to any uptick in yields and reduced bond-buying by the BoJ. Institutional investors with significant asset holdings in Japanese bonds could face losses if domestic rates move higher. For commercial banks, higher rates will boost net interest margins, but regulators are alive to the risk of Silicon Valley Bank-style dynamics from any losses on assets. Indeed, few bankers have experience of a rising rate environment. Borrowers accustomed to low rates could also face difficulty.
Third, in their search for yield some Japanese banks have engaged in riskier lending abroad. For instance, shares in Tokyo-based Aozora Bank recently slumped after it flagged losses tied to its US commercial property book. These exposures could have a knock-on effect at home.
For now, any major repatriation of investments or unwinding of the carry trade is unlikely. US bond yields are still significantly more attractive. A sharp and rapid step-up in the BoJ’s policy rate, which could also drive a significant appreciation in the yen, is off the table too. In any case, the central bank appears willing to intervene to support financial stability. But vigilance is important. Even if Japan’s policy rates do not move unpredictably, America’s might. That will affect spreads, exchange rates, and hedging costs. Other economic shocks could alter Japan’s domestic growth, inflation and public finance outlook.
The BoJ made a significant step on Tuesday. But the journey to normalising Japan’s monetary policy remains a long slog. Financial threats lurking after years of sub-zero rates have so far been tamed — in no small part down to the central bank’s clear and careful approach. That must now continue.
Corporate defaults at highest rate since global financial crisis, says S&P
More companies have defaulted on their debt in 2024 than in any start to the year since the global financial crisis as inflationary pressures and high interest rates continue to weigh on the world’s riskiest borrowers, according to S&P Global Ratings.
This year’s global tally of corporate defaults stands at 29, the highest year-to-date count since the 36 recorded during the same period in 2009, according to the rating agency.
Subdued consumer demand, rising wages and high interest rates, which hurt more indebted companies, had all contributed to the increase in the number of companies struggling to repay their debt, S&P said.
“What’s going on is exactly what’s been going on since the [Federal Reserve] began to raise interest rates” in March 2022, said Torsten Slok, chief economist at investment group Apollo. “Default rates are rising . . . because higher interest rates continue to bite harder and harder on highly levered companies.”
Companies to have defaulted in February included US ferry and cruise operator Hornblower, US software group GoTo and UK cinema group Vue Entertainment International.
Although the majority of defaults were in the US, Europe’s eight since January is twice as many as in any year since 2008, and more than double the number seen in the same period of 2023.
Three US healthcare companies — Radiology Partners, Pluto Acquisition and Cano Health — defaulted last month, in part due to the implementation of the No Surprises Act, which came into force in 2022 and caps the amount that providers can charge for treatments that patients did not choose and for which they are not insured, S&P said.
Fourteen, or roughly half, of the companies that have defaulted across the globe this year were classified by S&P as “distressed exchanges” — agreements that typically involve creditors receiving assets worth less than the face value of their debt, in a scenario that can help borrowers and private equity sponsors avoid expensive bankruptcy proceedings.
Consumer-sensitive stocks are most exposed to the potential for further defaults in 2024, according to S&P analyst Ekaterina Tolstova. Chemical and healthcare companies may also be at risk over the coming months given the sectors’ high concentration of poorly rated incumbent companies with negative cash flow, she added.
However, an improving macroeconomic outlook and hopes that interest rates will decline in the second half of the year mean S&P expects Europe’s default rate to stabilise at about 3.5 per cent by year end — in line with 2023’s figure.
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