The Asia Report is supported by Cathay PacificThis morning, S&P downgraded its outlook on Japan to negative based on its rising level of sovereign debt, and the threat it could rise even higher due to rebuilding costs associated with the earthquake and tsunami.
Markets did nothing.
There are several reasons for this, including the percentage of Japanese bonds owned by domestic institutions (94%). But there’s another important one, notably the primacy of yen-denominated assets for Japanese investors, according to Societe Generale’s Takuji Okubo.
Japanese institutions need to own assets denominated in yen to pay out to depositors in yen, and Japanese government bonds remain the lowest-risk, most abundant yen-denominated asset, according to Okubo.
What would have to change for Okubo to start to get worried?
Thus, for Japan to run into funding problems, what needs to happen is for Japanese households to desert yen in rapid manner. Is it possible? In fact, Japanese households are slowly starting to shift their asset into non-yen. The percentage of their financial assets in non- yen has risen from less than 1% in 1990s to slightly under 3% in recent years. However, it is a gradual process, and we argue that 97% of their assets are still safely in yen.
Okubo says a run on the yen would amount of Japanese investors moving their foreign currency allocations to 6 to 7%. This would reduce the amount of buyers in the market for Japanese government debt, and put pressure on yields.
Right now, we’re no where near that, and it seems it will take sometime to get there. By watch this number closely, it likely has more to do with stability in the Japanese debt markets than any S&P downgrade.
Photo: Societe Generale