Just about “everyone and their uncle” seems to be shorting Japanese government bonds at the moment, notes Louis-Vincent Gave in the latest note from the asset allocation and research house Gavekal.
Friends on trading desks call it the “Einhorn Effect”, he says, because of the famed Greenlight Capital founder’s recent speech on the challenges many governments will face servicing their debt, with Japan as a prime example.
Raising the prospect of what he calls a “currency death spiral”, Einhorn told a New York conference on value investing that Japan “may already be past the point of no return”. Never one to pass up an opportunity, however, Greenlight had added new trades to this investment theme, buying long-dated options on much higher interest rates in Japan and other developed regions - effectively giving the firm the chance to make big profits from a jump in rates. The options, bought from major banks, are tied to interest rates four to five years out, Einhorn noted.
Clearly, notes Gave, the market’s willingness to latch onto Einhorn’s comments reflect a greater willingness to kick the Japanese horse while it’s down. Indeed, commentators have had a field day in predicting doom for the world’s third-largest economy.
And why not, says Gave, adding: “Shorting the Japanese government has all the hallmarks of an attractive trade”.
That said, he readily admits that losing money on shorting JGBs is a “long-standing tradition for macro-traders”. Somehow, despite already drastically high debt levels (and what, as FT Alphaville noted, is an inevitable deluge of JGBs as the Hatoyama government struggles to fund its ambitious spending programmes) Japan “always manages to pull some trick out of its hat to keep the bond market steady”, he adds.
Perhaps Tokyo’s next trick, he wonders, may just be to effectively create a “tontine“ (in brief, a capital-raising scheme combining features of a group annuity and a lottery) - one in which the last surviving investor will be the Japanese government”.
CLSA’s Christopher Wood also has JGB shorts on his mind (among many other things) in the wake of remarks by Japan’s finance minister Hirohisa Fujii [aka Japan’s ‘minister of currency fluctuations‘], who said this week that the DPJ government may have to sell more bonds this fiscal year than the initially projected ¥44,000bn ($486bn) in order to make up for a shortfall in tax revenue.
Bloomberg quoted analysts saying that additional sales of new financing bonds may come in at Y10,000bn or more.
Indeed, as Wood notes, Fujii said tax revenues may fall below ¥40,000bn this fiscal year ending 31 March, compared with the projected ¥46,000bn - and with such a shortfall, government bond issuance may reach a record ¥50,000bn or 10 per cent of GDP. By Wood’s reckoning, this will put the general government debt, including local government debt, on course to reach 210 per cent of GDP by the end of this fiscal year, up from 200 per cent at present.
In response to Fujii’s remarks, JGB yields soared, with the rate on five-year JGBs up 2.5bp at 0.670 per cent on Wednesday, while yields on 10-year debt increased 2bp to 1.395 per cent and those on 20-year debt also added 2bp to 2.115 per cent.
Hirokata Kusaba, senior economist at Mizuho Research Institute in Tokyo, summed it up, telling Bloomberg: “Concerns over debt supply are gradually affecting the debt market like a body blow.”
So, concludes Wood:
With this initial sign that the DPJ is not willing to bite the bullet on government spending, macro traders should look to short the 10-year JGB as far out in time as possible.
But Tokyo can take heart that not all commentators and investors are dismissing Japan. Just last week, celebrity investor Jim Rogers told a seminar in Tokyo that he was holding some yen and expected the Japanese currency to appreciate in part Japan is a creditor nation, because of the diminishing use of it as a carry-trade currency given the other options available, and because of government incentives for repatriation.
Related links:
Japan’s sovereign debt crisis looms - FTfm
It is Japan we should be worrying about, not America - Daily Telegraph
Is the sun setting on Japan? - Barron’s
Japan’s new ministers for disruption - FT Alphaville
