The japan government bond yield is so low in comparison with US treasuries. It puzzles me since if both are considered risk free, the disparity will give a arbitrage opportunity and the gap shall eventually disappear in long run. After doing a few google researches here is what think:
- Two key concepts for any debt type of assets is default and yield.
- Inflation is the way to default for government's bond, which dilute the returns of creditor's investment on the asset
- The true return should be the nominal yield less the effect of inflation (directly deducting?)
- The government leverages the equilibrium between government yield and inflation which are at a different level comparing with UST yields and inflation.
- How to explain the disparity of inflation rate between two currencies? I'm not sure. may be in long run the inflation disparity will cause changes in the exchange rate. This is where the value of two nations meet and exchange with each other.
- So if US has higher inflation rate than JPY, then USD should be less and less valuable comparing with JPY, which is counterfactual. It suggestion the USD have other tools in its arsenal to force devaluation of JPY. What is it? It must be something pretty simple and intuitive from a business point view or from a trading point of view.
- Exchange rate risk is another layer of effects. Yields (interest) positively influence the exchange rate but inflation (default) negatively influence the exchange rate.
- There is no constant disparity for bond between US and Japan. Why? I don't have a logic to explain yet.
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