Investors are starting to believe that central banks are serious about raising interest rates.
Even here in gloomy old Blighty, Bank of England governor Mark Carney is succumbing to the idea that Brexit might not be sufficient reason to justify negative real interest rates for all eternity.
Markets have rather enjoyed all the free money in recent years, so it's no surprise that they're getting the jitters.
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But there's one major market out there where the free money shows little sign of stopping. And that's not the only reason to invest there...
The Bank of Japan's unusually farsighted decision
Back in September last year, the Bank of Japan (BoJ) tweaked its monetary policy. Rather than print a fixed amount of money every month to buy assets (such as bonds or shares via exchange-traded funds), the BoJ did something new.
The BoJ said that it would "fix" the ten-year Japanese government bond yield at 0%. So if the central bank needed to print money to do so, then it would print as much as it took. Similarly, if yields were happily hanging around the 0% mark, it wouldn't bother printing any money at all.
At the time, markets didn't pay that much attention. In fact, investors were a bit underwhelmed. Interest rates on a huge number of government bonds around the world were negative at that point. So the idea of "freezing" your ten-year bond yield at 0% didn't look particularly radical. All the pressure was for yields to fall even further.
Meanwhile, it looked as though the BoJ had run out of room for manoeuvre. On the one hand, a brief stab at negative interest rates had been a failure. It posed a threat to banks' profit margins, which would make them even more reluctant to lend. And that was the opposite of what the BoJ was trying to achieve.
On the other hand, there was also a wider reluctance to buy any more bonds. The only logical end-point seemed to be that the BoJ would one day own the entire Japanese bond market and no one knew what might happen then.
Japan had managed to disappoint yet again, it seemed.
Now, though, the shift towards "yield-curve targeting" is starting to look like a nifty piece of forward planning. Because now that the rest of the world's central banks appear to be getting itchy trigger fingers, interest rates on global bonds are starting to pick up.
If the BoJ can keep rates right where they are, then Japan should be well placed to benefit. The yen will weaken, inflation will rise, and lending will stay cheap at a time when it's getting more expensive everywhere else.
So how will that work?
Japan is determined to get inflation going
Let's step back a moment. There are two main reasons to print money to buy government bonds. The first is the asset-price effect. As a central bank, you buy government bonds, reducing the outstanding supply. As a result, the people who previously owned those government bonds have to buy something else.
Some of them just buy even more government bonds that they hope to flip to you at lower rates in the near future. But others buy slightly more adventurous stuff corporate bonds, maybe. And the people who they buy the corporate bonds from then buy something riskier again.
So you get this "hot potato" effect, whereby the central bank sucks up the supply of "safe" assets and bounces everyone in the markets into riskier assets. The price of everything goes up, which makes it easier for companies to raise funds and for banks to remain solvent.
The second (and connected) reason is to drive down the cost of borrowing. All else being equal, as yields on the "safest" assets fall, so should yields on riskier assets. If your cost of borrowing is cheaper across the economy, then people should borrow more and spend more and you get growth and all that other good stuff.
However, there's another way to keep interest rates low without having to keep pumping lots of money into the market. If investors are convinced that you as a central bank, will do "whatever it takes" to keep a price at a certain level, then markets will automatically do the job for you.
If as a central banker, you are trying to both avoid negative interest rates and assuage fears that you own too many government bonds, then this is the perfect way go about it.
The BoJ has said that it will keep the ten-year at 0%. And because markets believe the central bank, it doesn't have to buy anywhere near as many bonds in order to achieve the same result.
For example, last week, the BoJ had to step into the bond market for the first time since February. As Pantheon Economics points out: "The central bank offered to buy the benchmark ten-year bond at 0.11%. No bids were tendered and yields dropped back below 0.09%."
But that pressure has to show up somewhere. "With the ten-year fixed, the currency is forced to do all the adjusting between Japan and the rest of the world. As the BoJ defended the target, the yen sold off 0.7%."
So the shift seems to have worked well. "The BoJ has managed to hold the target, while purchasing fewer bonds and the yen is 13.5% weaker than when the switch was made."
But what now? The BoJ still has a 2% inflation target that it keeps saying it plans to hit. Yet, if the global bond slide continues, the central bank will come under more and more pressure from the market, which will keep testing its resolve.Pantheon therefore expects the BoJ to raise its ten-year target to 0.2% from 0% by the end of the year.
However, by then, Japan may well be ready for it. Wage inflation is gradually creeping higher (in May, regular earnings were up by 0.9% year on year, which sounds pitiful, but is actually an impressive bounce by historical standards).
The jobs market is as tight as it's ever been, so this should continue. And consumer spending is improving too, according to the latest Economy Watchers Survey partly because consumers are also becoming more convinced, after decades of deflation, that prices might actually start to rise soon.
Meanwhile, share prices are cheaper than in most other major markets and if the yen continues to struggle, they're only likely to benefit further. In short, stick with Japan.
