Japan's stocks, bonds, and currency all plunge; Deutsche Bank: Compared to U.S. market volatility, the Japanese market is more worrisome!

The Japanese financial market is currently experiencing a storm of "triple sell-off in stocks, bonds, and currency." Deutsche Bank has issued a warning, stating that the current turmoil in the Japanese market is more worrisome than the recent volatility in the U.S. stock market. It recalls the crisis in 2022 that almost destroyed the British bond market, and a potential risk of capital flight is building up.

Market volatility intensified on Thursday. The Nikkei 225 Index opened lower and continued to fall, with the decline at one point approaching 3%. In individual stocks, SoftBank fell 11%, hitting a recent low; Kioxia plunged as much as 16% intraday.

Meanwhile, the yen exchange rate fell to the lowest level since January this year, approaching the warning line that could trigger intervention by the Bank of Japan.

The bond market is also under pressure, with the 30-year Japanese government bond yield rising to its highest level in decades.

At the core of this series of chain reactions is deep market concern over the fiscal policies of Japan's new government. According to reports, the Japanese government plans to launch the largest fiscal spending package since the pandemic. George Saravelos, Global Head of Currency Research at Deutsche Bank, said that this massive stimulus plan, combined with the consistently dovish stance of the Bank of Japan, is fueling worries about the deterioration of Japan's fiscal standing and shaking investors’ confidence in Japanese domestic assets.

Albert Edwards, Global Strategist at Societe Generale, also expressed similar concerns, describing the rise in long-term Japanese bond yields as "a major warning signal rarely noticed by investors." Analysts warn that if investors lose confidence in the Japanese government and central bank's commitment to low inflation, the rationale for selling Japanese assets will become solid, potentially causing a more destructive capital outflow.

Simultaneous declines in stocks, bonds, and currency expand signs of capital flight

Deutsche Bank pointed out in a report titled "This is Worrisome," that both the yen and 30-year Japanese government bonds have fallen more than 5% in recent weeks, while fixed income markets in other parts of the world have rebounded over the same period. This decoupling highlights the unique predicament facing the Japanese market.

The latest sharp decline in the Japanese stock market is seen as an "obvious signal" of spreading market pessimism. Deutsche Bank analyst George Saravelos warned that if price volatility in the bond and currency markets spreads to the weakened stock market, it will be a sign that capital flight is expanding in scale.

Thursday’s market performance seems to be confirming this prediction. Data shows the 30-year Japanese government bond yield has risen above 3.35%, compared with just around 3% at the beginning of the month.

Deutsche Bank Warning: Beware of a repeat of the 2022 UK market turbulence

Analyst Saravelos compared the current situation in Japan to the "Truss crisis" in the UK in 2022.

Back then, a tax-cut plan proposed by the then British Prime Minister without financial backing sparked panic among investors, causing the pound to plunge to a 37-year low and pushing the UK government bond market to the brink of collapse. Saravelos believes that Japan is sending similar signals: "loss of confidence" in its domestic asset base.

He said, "Both the yen and the long end of the Japanese government bond market have begun to decouple from any fair value metrics, and intraday correlation is accelerating."

He further explained that the long-term stability of the Japanese market relies on a combination of high public debt and high private savings, with the core being stable inflation expectations. Once domestic investors lose confidence in the government and central bank’s commitment to controlling inflation, “the reason for buying Japanese government bonds will disappear, and capital outflows will intensify.”

However, the report also points out that the UK bond market crisis in 2022 was exacerbated by forced selling from pension funds due to leveraged investment strategies, and there is currently no sign of similar leveraged risk in the Japanese market.

Huge fiscal stimulus and dovish central bank stance raise concerns

The immediate trigger for market turmoil is the spending plan of Japan’s new Prime Minister, Sanae Takaichi. According to reports, the size of the plan will be the largest since the COVID pandemic. In the eyes of investors, such a huge fiscal stimulus, combined with the Bank of Japan's reluctance to tighten monetary policy, will inevitably lead to a deterioration of Japan’s fiscal situation.

In his report, Saravelos analyzed that Japan has the world’s largest government bond market as a percentage of GDP, and also has some of the world's wealthiest households. This "high public debt, high savings" structure is the cornerstone of its capital market stability. However, the stability of this system ultimately depends on stable inflation expectations. If domestic confidence is shaken, the entire system could face the risk of collapse.

Albert Edwards of Societe Generale also believes that the rise in yields, while "not yet a panic sell-off, is a steady, slow, and relentless increase." He even predicts: "This long-term bear market in government bonds, led by Japan, is doomed to overturn the overvaluation of stocks and real estate over the past 40 years."

What to watch: Capital Flight and Official Action

For now, the Bank of Japan and the government seem tolerant of recent market volatility. But Saravelos questions whether Japan's government can continue to remain silent if current price trends persist.

"We will closely monitor in the coming weeks whether Japan's market shows broader signs of capital flight," Saravelos said. "A clear signal will be if current price trends spread to weak stocks, and Japanese government bonds continue to decouple from global fixed-income trends."

For investors, the Japanese market's "triple sell-off" means systemic risk is rising. Compared to short-term volatility in U.S. stocks, domestic capital flight driven by loss of credibility in fiscal and monetary policy could have deeper and more destructive consequences.

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