Albert Edwards thinks investors are too focused on the AI bubble (or “bubble,” in scare quotes, if you think it’s more epoch than speculative mania) and not focused enough on Japan, where a crisis is brewing.

I try to highlight Albert’s missives when he mentions Japan, because on a lot of important vectors, that’s his wheelhouse.

His latest, sent around on Thursday, feels familiar. If memory serves, he penned something similar a while back. Before I get to it, allow me to contextualize the situation.

America’s decision to go to war with Iran was a problem for Sanae Takaichi domestically: Japan relies almost exclusively on imports for its oil, and the vast majority of the country’s imported crude comes from the Mideast.

Surging energy prices can exert upward pressure on dollar-yen, exacerbating FX pass-through inflation and chancing a terms of trade shock. We saw that in 2022 when Japan’s import bill spiraled due in no small part to the juxtaposition between soaring commodity costs and the ever-weaker currency.

Although the BoJ’s tightening policy, so too is the ECB and the BoE may hike again as well. I have my doubts about Kevin Warsh’s willingness to tighten given the political pressure he’s under, but the Committee over which he presides is hawkishly inclined for the time being. (Just ask the June FOMC minutes.)

If the BoJ’s counterparts are compelled to pivot back to hikes, the bank would have to tighten even faster to avoid a scenario were rate hikes in other locales blunt what would otherwise be a yen-favorable monetary policy conjuncture. Rapid hikes in a country with an enormous debt burden is a dicey proposition.

Super-long Japanese yields are up the most among developed market sovereigns since the war started, but the yen’s nevertheless loitering near the weakest against the dollar since 1986. Specifically, USDJPY remains north of 162, which means intervention risk’s ever-present.

Domestically, Takaichi needs to address consumers’ cost-of-living concerns if she hopes to sustain the sky-high approval ratings which informed her decision to call a successful snap vote earlier this year. Soaring oil prices and accompanying pressure on the yen don’t help.

Edwards’s argument, in essence, is that investors have become so accustomed to Tokyo’s weak yen policy, that the divergence between rising bond yields and a currency that can’t get off the mat to save its life, isn’t getting the same kind of attention accorded to, for example, sterling and gilts when both selloff together.

The figure below, from Albert’s latest, illustrates how extreme this divergence is by now when you plot USDJPY with 10-year UST-JGB rate diffs.

“The BoJ’s direct suppression of JGB yields below where they would otherwise be if left to market forces, has started to trigger a revolt in the currency markets,” Edwards wrote. “What should ordinarily be a bond ‘crisis’ — as 10-year yields jumped much higher to their ‘correct’ market determined equilibrium level has morphed into a slow-motion currency crisis.”

The problem — and Edwards readily admits as much — is that after decades of shrill warnings, market participants’ ears are deaf to debt crisis calls as they relate to Japan.

But if you ask Albert, this time might be different. There’s also a read-across to US financial assets.

“Over the last few decades, global equity and bond market valuations have benefited from Japan suppressing their bond yields and providing ample surplus QE liquidity to the world,” he wrote. “Do you really think the US equity market, for example, can sustain a 20x+ forward PE if JGBs continue their upward trajectory and converge to US yields levels?”

He meant that as a rhetorical question. But he answered it anyway: “I don’t.”