After the highly unusual flurry of excitement and speculation in the normally dull Japanese government bond market through early November, FT Alphaville, among others,recently noted the end of the short-squeeze fest in JGBs.
But just as it seemed the market was about to revert to its plonking, mild-mannered pace, Japan has wheeled out the spectre of deflation - or rather, the government has officially acknowledged what has been clear since February: that “the Japanese economy is in a mild deflationary phase”, to quote an official statement from Friday.
As the FT noted:The Bank of Japan, which has been resisting public calls by politicians for a more aggressive approach, moved towards a neutral stance on the risk of inflation on Friday. “We want the BoJ to extend support on the monetary policy front in overcoming deflation,” said Naoto Kan, deputy prime minister. Hirohisa Fujii, finance minister, and Shizuka Kamei, financial services minister, have also called on the BoJ to do more. Deflation, which bedeviled Japan through the 1990s, is a symptom of a contracting economy, as wages and prices spiral downwards. Consumer prices were down by 2.2 per cent on the previous year in September, or by 1.0 per cent excluding fresh food and energy. Although year-on-year inflation first turned negative in February, the government only now declared … a “mild deflationary phase”.The deflation kerfuffle has added to pressure on the Hatoyama for more action on the fiscal stimulus front – which by implication means more public spending. In turn, that is likely to mean more JGB issuance — and some real concerns about over-supply.
Yet, many big institutional investors appear to be betting that bonds hold more promise than stocks in a (now offically acknowledged) deflationary environment. Last week, the finance ministry drew over Y1,000bn ($11.3bn) of bids for a 40-year-note with a nominal yield of just 2.2 per cent. Many also seem to be betting that the Bank of Japan may succumb to pressure for more deflation-fighting action on the monetary policy front, further loosening by stepping up bond purchases and bringing down yields, despite its rock-bottom interest rate policy.
Now the irrepressible Jonathan Allum at KBC Financial Products has weighed into the saga, pulling of the feat of issuing a highly entertaining note about fiscal policies and JGBs. He begins:
I have nothing against Agatha Christie. I no longer read her novels (I have many other calls on my time) and I did read dozens of them in the mid-sixties… In brisk muscular prose… they do what has to be done. They describe a murder (or series of murders) and the attempts of the detective to solve it (or them). At the end of the book the villain is unmasked and the clues, which have been sprinkled through the preceding pages… are highlighted and order is restored. The reader is entertained. He is not enlightened or moved, his life has not been changed… Christie is genre fiction — it rarely strays outside certain guidelines and the reader knows just what he is getting. He should expect no more.
I have recently read a number of bloodcurdling articles about Japan’s imminent fiscal implosion. This is hardly a new story and… they seem like the proverbial London bus — there are none for ages and suddenly a whole gaggle turn up together. Thus in quick succession we have had Jonathan Laing in Barron’s (28/11), Ambrose Evans-Pritchard in the Daily Telegraph and Edward Chancellor in FTfm (both 2/11), Lindsay Whipp and Gillian Tett in the FT (13/11) [see other links here]. There have been many others. How seriously should we take all these intimations of the apocalypse?
Indeed, notes Allum, many of these articles are, like Agatha Christie, essentially genre writing (though he adds, “I am not suggesting that it is fiction”). The doomsayers, he reasons, typically cite market moves to support their arguments:
Some are alarmed by the rise in long term JGB yields. It is true that, to pick two dates most convenient to their arguments, 10-year JGB yields rose from 1.24% to 1.45% between the 6th October and the 6th November. The problem with their interpretation of this move is that a) it was not peculiar to Japan — bond yields were rising across the globe b) it subsequently reversed with 10 year JGB yields back down to 1.3% and c) the impartial adviser will be impressed, not by the speed of the rise in yields but just how they remain very low, by any historic standards save those of modern Japan (and, some say, 17th century Genoa).
Some of the doomsayers recognise that the JGB market is notable for its strength rather than its weakness and prefer to look to the CDS market as a true reflection of the rising concern over Japan’s creditworthiness. But, says Allum, referring to the battering taken by the “efficient market hypothesis” crowd, the more liquid and transparent a market is, the more likely it is to carry genuine information. “On that basis it would seem perverse to prefer the CDS to the JGB market since the former is, despite substantial growth over the last year, still tiny”. He continues:
According to figures in [Mondy's] FT, the gross notional value of CDS outstanding on JGBs is $15 billion — for Ukraine the figure is $44 billion. Despite this discrepancy in size between the JGB and CDS markets it is argued that the latter, which is dominated by foreigners, gives a truer picture of the debt position than the former which is dominated by domestic investors.
And another key point:
If one accepts that the JGB market is failing to give correct signals over the state of Japan’s finances, there is another and even larger dog that has failed to bark in the fiscal night. Perhaps the Japanese government is rigging the JGB market. But what of the foreign exchange market? If Japan is really teetering on the edge of a financial volcano, why is the yen so strong?
He concudes:
The focus on the question of whether there has been undue government influence in the JGB market ignores the structural factors that continue to tend to support it. One, of course, is that many JGBs are bought by other arms of the government. The second is that Japan runs a structural savings surplus. In effect, the Japanese private sector saves enough to finance the public sector deficit and still has quite a bit left over… It is true that the savings rate has been in decline for years but this only measures the financial surplus of the household sector. The private sector is still a large saver.
This is the flip side of Japan’s current account surplus… Economists have, for many years, argued that Japan’s surplus is bound to contract. It did dip sharply as trade collapsed in late 2008/early 2009 but has subsequently recovered. What is interesting here is that in the 2001-7 period of expansion — and this was not true of the last cycle — the current account surplus has become substantially larger than the trade surplus and is thus much less vulnerable to the vicissitudes of trade. This structural support for the JGB market may not persist for ever but the obituaries seem a little premature.
Arigato, Allum-san.
Related links:
Japanese bonds gain on speculation BoJ to expand monetary easing – Bloomberg
More fun with JGBs, more headaches for Japan – FT Alphaville
Japan, Einhorn and ‘tontine’ fantasies – FT Alphaville
Japan’s JGB dilemmas – FT Alphaville