Thursday, July 24, 2014

Japan Breakeven Data Update

Just for my reference, I pulled off some of the Japanese Breakeven rate info off Bloomberg.  As always, this data may have some problems.  These contracts are not very liquidly traded and have risk premiums embedded in them.

1 year, 4.38%:

5 year, 2.33%:

10 year, 1.21%:

Jason Smith sends me to this Scott Sumner quote in a comment on the previous post:

4.  Japan will be hit by an adverse supply shock next year (higher sales tax rates) which will boost inflation–making it look like they will hit their 2% target.  Don’t be fooled.  When the effects wear off Japanese inflation will slip back below 2%. Because of Japan’s fiscal situation, it has no good options.  The sales tax increase will hurt the economy, but is needed.  I used to think they should delay it, but now I think they should bite the bullet and do it.

Maybe.  Certainly the VAT is affecting the CPI and through it the break even rates.  Will inflation backslide below 2%?

The 2 year break even is 3.317%.  That implies a second year rate of 2.26%.  Using the five year, we get a final four year rates of 1.82%.  Using the ten year and five years together, we can see that the market predicts the last five years to have inflation very close to 0, about .5%.

So the market is looking forward to several years of rising prices.  That's quite a different prediction that many gave when Abeonomics started.  Will the BOJ hit it's of 2% over five years?  It looks like they are expected to be around that range.  Certainly with some help from the VAT, but even in the last four years prices are expected to rise.

On a long horizon, will they revert back to zero?  Maybe.  Maybe as soon as everyone comes around, everything will start heading backwards.  I would caution that the longer we go out in time, the worse the expectations theory probably is.  Risk premiums may be more important to model on longer horizons.  Ignoring them for several years compounds the error.  


  1. Charlie, it's "Jason" not "Jeff" Smith.

  2. Oops, I knew that. Must have had a momentary lapse and inserted the famous econometrician's name instead: