A piece of history

Yesterday saw the release of an historic piece of data. For the first time since the bubble burst, Japanese land prices rose on the year. If ever there was a sign that the dark days may finally have passed, this is probably it. Naturally, as the article linked above suggests, the very act of land price recovery has already raised fears of an incipient property bubble. Indeed, word on the street is that such fears were one of the reasons for the BOJ’s abandonment of quantitative easing last year. Regardless, the recovery in activity and asset prices is prompting an increasing clamor for a more aggressive normalization of BOJ rates.

Even if the BOJ continues to take its time, an argument could be made that JGB yields should rise. Real activity remains robust, confidence remains firm, and, from a longer term perspective, government bond yields have tracked land prices fairly well over the past 20 years, albeit with a modest lag. Benchmark yields have already spiked 7 bps on yesterday’s release.
An obvious and interesting question is whether a further rise in yields would provide succor to the yen. The answer, as far as Macro Man can see, is possibly but not definitely. The problem is that life insurance companies have guaranteed returns to their policyholders, and for most of them the hurdle rate is substantially (0.70% - 1.00%) above the current JGB yield. As such, a rise from 1.60% to 1.80% is unlikely to prompt a change in behavior. Should yields rise close to 2.00%, on the other hand, some lifers will probably increase their domestic bond weightings at the expense of partially hedged foreign bonds. Over the past year, for example, the yen appears to have been positively correlated to yields with yields above 1.80% and negatively correlated to yields below that rate.

As a result, Macro Man is not particularly concerned with his short yen beta position at the moment. If anything, he reckons the yen is probably a sale on rallies given the anecdotal increase in Japanese demand for foreign assets over the past week or so. This doesn’t mean that there is no trade, however. JGBs have been confined in a narrow range for more than six months, with 135 on the continuous future proving to be a tough nut to crack.

The recent sell-off has broken a short term uptrend line and threatens the 55 day moving average, a breach of which should get CTA sellers involved. This looks like a nice set up from both a fundamental and technical perspective, a confluence of factors that suggests a relatively aggressive risk budget. Macro Man will therefore risk slightly in excess of $500k by selling 50 futures at Monday’s open should the open be greater than 134.25; if it is below that level he will be 134.25 offer. If executed, he will place a stop at 135.50.

Next Post »


Click here for comments
March 23, 2007 at 1:41 PM ×

Macro Man, you are a wise man. But benchmark JGB yields did not rise on the land price survey, not matter what Bloomberg reports. That's simply a falsehood. But I guess truth matters little when it comes to such reporting. Today's move was entirely technical, I can say, without the participation of domestic investors.

March 23, 2007 at 1:44 PM ×

MM -
Yeah, I agree the YEN is a P.O.S.(but not inherently, but by design). That said, the only thing between the dollar and oblivion is a massive change in median household incomes (rather unlikely given the gluttony of capital v. labour and globalisation pressures) OR yet more consumer debt. And one might conjecture the BRL or whatever other NIC or BRIC with yield will not feel "it" when oblivion arrives, but I am rather more conservative at heart and cannot countenance testing such a hypothesis with accumulated wealth and childrens' future etc. Maybe with OPM if I cared not about shooting the moon and the outcome of losing.

So yes, the YEN sucks, but its not about the YEN, its really about the dollar, and the Japanese both as household and corporate savers, and as facilitators/creditors are the reasons the trade can, and will (despite the correctly crappy fundsamentals you highlight) act like a crowded trade in liquidation.

Where will JPY/USD be (or state-change to) when FRB actually cuts rates to insure US real PCE doesn't subprimed? The staus quo will see real USA PCE roll over as credit growth will finally be insufficient to fuel the consumer. Raising rates will only hasten the same. Lowering rates will have little effect on REAL PCE, but will set off the dreaded chain reaction of dollar drop, carry unwind repatriation and Japanese corporate hedging, and rather higher long rates as the USD and the US bond finds some new equilbirium - likely to be some distance from its current locus.

Macro Man
March 23, 2007 at 3:52 PM ×

Anonymous, JGBs did gap a lower by 20 ticks today, but point taken that they sold off pretty steadily thereafter, suggesting that a lot of the selling was price-driven.

Cassandra, it is possible for two people or reasonable intelligence and goodwill to look at the same set of factos and reach dramatically different conclusions. I think that's where you and I are at the moment on a couple of things.

I will readily admit that should certain players (namely, FX reserve managers) plunge into yen with gusto, USD/JPY will be a lot lower. However, I think it will be in their best interests not to create a dislocation by saying "200 billion dollar-yen yours, at best" one sunny Monday morning. And as has been discussed ad nauseum, I do not believe that short yen positions are terribly large at the moment, particularly in comparison to 1998.

On the US, I think I have a more optimistic outlook than many if not most. I believe that FX reserve manager demand for dollars is equally culpable for the US current account deficit as US consumer demand for products, and that the imbalances can close organically and without substantial disruption should either side choose to alter their side of the bargain.

While incomes are clearly important in determining consumption patterns, so too is net wealth. And while one could forecast that US household wealth is built on a house of cards, failing a collapse (which I concur would bring down a whole host of current market darlings) in that wealth, consumption does not looks particularly aberrant from an historical perspective. Indeed, the anomaly is household wealth to incomes, which makes sense given the globalization/ capital versus labour issue to which you allude.

March 24, 2007 at 2:17 PM ×

Best bet: Fed panics when stock market sinks. Can't have both housing and stocks falling at same time - then no collateral for further increases in consumer debt, leads to falling consumption.

Rate cuts lead to declining dollar, in herky jerky discrete bumps downward, jarring robo-trader programs. Dinosaurs roar, EM stocks tank, page one stories scream, Japan/China/SaudiArabia govts chastise US, threaten to pull support for deficits. They were tired of funding Iraq war anyway.

Fed panics more, reduces rates quickly, jeans go to $100 at Walmart. Dissatisfaction all around. I don't know where exactly we wind up but direction based on predictable "Fed Put" actions if any little thing causes trouble for stock market in US. It won't be foreign CB's who cause slide, either. We reserve right to use gun on own foot, thank you.