The thesis is that as inflation rises, interest rates will as well; meaning bond values will drop, causing balance-sheet issues for the banks. Although this thesis is sound, I believe it is incomplete and ignores several key facts:
- Japan is still stuck in a deflationary cycle, and the May 30 Japanese CPI and PPI data showed this very clearly.
- Although comparisons are plentiful, U.S. monetary policy in its totality is very different than that of Japan.
- And perhaps most significantly, U.S. banks don't own a lot of U.S. Treasuries or TIPS.
As a result of having a zero interest rate policy for more than a decade, regional Japanese banks and insurers already mark to market, and are therefore very susceptible to a rise in interest rates. Investors do not need to panic and should not view this as a broad-market sell signal. Rather, this is a real-time case study of how equity markets react to a rising interest rate environment. Based on this, we will be monitoring the reaction of various market segments within the Japanese equity markets in an attempt to provide us with better insights as to how U.S. markets may react if or when the Federal Reserve begins to exit its current easing strategy.