US-Japan Bailout Fails to Fix Japan's Bond Problem

The US Treasury's decision to partner with Japan in propping up the Yen has raised concerns about the risks created by government intervention in fixed-income markets. According to a recent article, bonds provide the foundation of risk for the entire financial system, and excessive intervention can distort how capital is allocated and lead to pricing risk.

Japan's decades-long effort to keep its bond yields low through buying its own debt or enacting regulations has enabled it to borrow despite anemic growth. However, this repression has come at a cost, including depressed growth, mispricing of risk, and the creation of the Japanese carry trade, where investors would borrow at low rates in Yen and invest elsewhere.

The Bank of Japan's attempt to let rates increase in a controlled manner was not credible, and Japan is now trying to defend its currency. The US Treasury stepped in to support the Yen, but this intervention may be akin to putting a finger in a leaky dike. The underlying fundamentals remain unchanged, with Japanese yields still much lower than they should be given inflation and rising debt burden.