Japan already has the heaviest debt load among industrialized countries, equivalent to about 240 percent of gross domestic product, according to International Monetary Fund estimates. One possible further trigger of yen weakness would be credit-rating downgrades of Japanese banks and of the government itself. Kono says that would make it difficult for lenders to borrow foreign currencies and force them “to sell yen to buy dollars, just as they did during the 1998 financial crisis” in Japan.
“The biggest problem is that as a result of monetary policy that keeps interest rates excessively low, fiscal discipline is weakening, and that may be promoting fiscal expansion,” Kono says. Should the government not act until after inflation has already accelerated to 4 to 5 percent and the yen is far weaker than 150 per dollar, it may have to raise the sales tax to as high as 25 percent. As it is, Prime Minister Shinzo Abe has delayed lifting the consumption tax to 10 percent from 8 percent.
A crisis in Japan could send ripples through the global economy. The global market, for example, might begin to demand higher interest rates to compensate for holding bonds of other countries that are also saddled with an aging population and large public debt. —Takashi Nakamichi
The Oil Trigger
“Don’t dismiss oil just because it smells like yesterday’s trade,” says Sir Michael Hintze. The British-Australian head of CQS U.K. LLP, the hedge fund he founded at the turn of the century now worth $14 billion, warns the one thing that could upend the status quo assumptions about global growth is a redux of cratering crude.
“Such an event has the potential to spark a wider contagion,” he says. Hintze points to $35-a-barrel oil as that trigger point. That price may not feel imminent—and he emphasizes that he doesn’t see this scenario panning out anytime soon because of the recent developments in the Middle East—but that doesn’t make it improbable. The 64-year-old Hintze, a staple of the conference circuit and a member of the Vatican Bank board, says investors will have hell to pay if they turn a blind eye to what another spell of oil below $30 can wreak on the global financial system.
Worse still is the risk that price level proves sticky, which could happen if suppliers such as Saudi Arabia and Russia keep pumping oil to fuel their fiscal compulsions. Such a scenario would hamper U.S. energy producers with low credit ratings and impair their ability to come good on their dues. And with credit investors heavily exposed to those companies, the resulting impulse to sell and then rush to contain losses could spread to other parts of the financial system. Add to that the number of ETFs that have become prominent credit investors, Hintze says, and you have a stress point to be wary of. — Sridhar Natarajan
All These Eggs Are in One Basket
A somewhat obscure corner of the U.S. financial markets, one buried deep within the plumbing of the debt markets, is about to become the only corner of its kind.
Come mid-2018, just one entity—the Bank of New York Mellon Corp.—will be responsible for ensuring that almost $2 trillion of securities financed by so-called repurchase agreements are cleared and settled each and every day. JPMorgan Chase, its lone longtime rival, has elected to exit the business, in part because regulators pushing for banks to boost capital and cut leverage made the dealings costly and onerous. So while Bank of New York already was the dominant of the two—accounting most recently for 80 percent of market share—there’s no Plan B anymore.
Even as Bank of New York has plowed billions into improving and upgrading its technology and systems, some investors worry that any sustained outage could cripple the country’s debt markets. Not only do repos support liquidity in the $14.3 trillion Treasury market, but the financing they provide also helps grease the wheels of trading in assets as varied as stocks, corporate bonds, and currencies.
“A single point of failure in the U.S. government-collateralized repo market, which is huge and is essentially the liquidity engine for the country, is a little bit unnerving just in itself,” says Adam Dean, managing director at Square 1 Asset Management Inc. “It’s not an ideal situation.” — Liz Capo McCormick