Moody's downgrade of Japan to A1 only deserves a short comment, as it will likely have very little effect on bond yields, the economy or risk-asset psychology. The major reason why is due to its odd premise of predicting too much success of Abenomics, while most market observers are not so optimistic.

However, assuming Moody's is correct and inflation expectations become more stable, then the economy should have improved, fiscal receipts should have risen sharply, and the BOJ could reduce its program gradually.

Interest rates would very likely rise in this case, but one should not expect 10Y yields above their pre "Lehman crisis" level around 1.5%. This level would not cause a crisis of any kind and would, in fact, be a rather normal level once the economy stabilizes, in our view. Any indication, however, that the VAT hike was to be delayed even further might cause some concern, but this is unlikely in our view.

Some analysts are likely to suggest that the real risk for JGBs is that the Yen will weaken substantially in an uncontrolled fashion. However, one should note that Japan has more than 1.2 trillion dollars of foreign exchange reserves to prevent such an occurrence, so we deem such a scenario as very unlikely.

Lastly, one should remember that Moody's cut Japan local currency long-term debt to A2 in 2002 (before raising it by several levels later in the decade), sparking Western media comments that the rating was below that of Botswana and thus, the beginning of a crisis, but in reality, Japan's bond market has behaved much more like AAA ever since then.