Last week I gave a clear warning that Japan was at the epicentre of market moves world-wide. I gave that warning before the large fall in their stock market.
Of course I had no idea that on the very day I wrote my article we would see huge gyrations in their stock market. But I have followed the immense moves occurring in Japanese government bonds (JGB’s) and knew we weren’t far away from some fireworks.
And it seems to me the worst is far from over…
The falling bond market is a completely sensible reaction by investors to the Bank of Japan’s (BoJ) threat of seeking 2% inflation. Most are of course sceptical that the BoJ can achieve a 2% inflation rate. But it’s hard to see anyone buying bonds at a 0.5% yield when the central bank is doing all in its power to ensure investors ultimately receive a negative real yield.
Kuroda, the BoJ governor, has even met with large holders of JGB’s begging them not to sell out. That course of action won’t work. The first man out the door is better off. Who wants to be left holding the bag if Japanese government bond’s collapse further?
Even though the Bank of Japan is soaking up 70% of all new issuance, Japanese government bonds are still selling off. I’m sure they still have tricks up their sleeves (they always do), but I think we are still in the early stages of a large exodus out of Japanese bonds.
Matters are certainly not being helped by the rise in yields on US Treasuries. 10 years are now at 2.06% and heading higher. That will place upward pressure on Japanese yields regardless of what the BoJ wants.
If there is one thing that my reading of economic history has taught me it is that crashes occur due to tensions created between the large central banks.
If Bernanke is really serious about slowing down asset purchases and the BOJ is in the early stages of firing up their printing presses that will create a lot of tension between their respective bond markets. Kuroda may find he is pushing on a string in his attempt to cap interest rates. Motherhood statements saying that it is ‘extremely desirable‘ for the nation’s debt market to be stable mean less than nothing.
It is the Bank of Japan’s action that is creating the volatility, so it’s hilarious to hear them complaining about it.
All Hell to Break Loose in Japan
I have a big bag of popcorn and I’m eagerly awaiting the next instalment in this saga. Will the markets finally stand up to the immense arrogance of the central banks? Or will they get beaten back into submission? The Japanese government bond’s are at the core of this battle between sound economics and the will of a few men. We know that economic truth must win out in the end, but it can take many years to play out.
The BoJ has now placed a line in the sand at a 1% yield in the JGB’s. Last week, before the fun and games began I said ‘it is going to be very interesting watching how their bonds behave once they start heading above a 1% yield.‘
Now that the BoJ has shown its hand and intervened in the JGB’s at a yield of 1%, I can assure you that if yields bust out above that level then all hell will break loose.
I think it’s a similar situation to George Soros’s bet against the Bank of England (BoE). The BoE drew a line in the sand in the Pound and Soros didn’t think they could hold it. He bet against them and won.
If the BoJ wants to print their way to a 2% inflation rate then their bonds won’t stay below a yield of 1%.
But while that cauldron starts to boil there are some very interesting charts that I’ve kept my eye on.
The Dax (German), FTSE (English) and S+P 500 (American) stock markets are all resting at or above all-time highs. They are potentially tracing out a triple top which would be very bearish if confirmed:
DAX, FTSE and S+P 500 Weekly Chart
Source: Slipstream Trader
All of my long term trending indicators are still pointing up in each index so it’s still early days, and topping formations can take months if not years to form, but looking at that chart I would have to say you’re mad if you are buying the stock market at these levels.
With US bonds selling off, their yield is now higher than the stock market. It won’t be long before we see investors switching back into bonds from equities. Especially if economic data continues to worsen. If Bernanke pulls back from QE perhaps we’ll even see bonds and equities selling off together. God forbid.
High yield junk bonds are an immense accident waiting to happen. How could it be that investors think it’s OK to buy the least credit worthy debt at the lowest yield EVER when the macro data continues to keel over? The mind boggles.
Yesterday the JGB’s sold off hard and closed at a yield of 91bps after starting the day at 83bps. That’s a very large move. I’ll watch the trading in Japanese government bond’s very closely over the next few days.
Murray Dawes
Editor, Slipstream Trader
From the Port Phillip Publishing Library
Special Report: Enter the Slipstream
Daily Reckoning: The Japan’s Nikkei is Starting to Crack
Money Morning: A Revolution in the Share Market is Coming…
Pursuit of Happiness: How One Reader Saved $300 with a Simple Phone Call
Murray Dawes
Editor, Slipstream Trader
