Japanese Bond-Stock Comovements

Servicing the Japanese government debt will cost more than 31 trillion yen in Fiscal Year 2026. This comprises 26% of government expenditures. The interest rate on Japanese government bonds (JGB) is thus important. Finance theory teaches that assets’ required returns depend on their risk characteristics. Assets whose returns covary positively with stocks are riskier and must offer higher expected returns. From 2007 to 2021 JGB returns covaried negatively with Japanese stock returns. As the Russia-Ukraine war and the U.S. Iran war stoked inflation, however, Japanese bond-stock comovements turned positive. The Eurozone and the U.S. exhibited similar bond-stock covariances as Japan did. This indicates that global supply shocks that raised energy prices and stoked inflation increased the riskiness of sovereign bonds throughout the developed world. Japan will not be able to prevent global supply shocks that raise oil prices and inflation. It should instead encourage businesses to reduce their exposure to fossil fuels and to choose environmentally friendly production methods. It should also invest in technologies to improve wind, solar, and hydro power and reduce Japan’s exposure to increases in the prices of food, fertilizers, and commodities.