MacroScope

The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:

It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.

Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:

At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.

Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.

Spain’s borrowing costs are likely to soar at an auction of 12- and 18-month T-bills after its 10-year yields were pushed through the totemic 6 percent level on Monday. The history of the euro zone debt crisis shows that once above 6 percent the spiral accelerates and before you know it you’re at 7 percent – the level generally seen as unsustainable for state financing.

Worryingly, Spain is dragging Italy’s yields up in its wake. But in Spain’s case, there are strong reasons for caution about imminent disaster. The government cannily used ECB-created benign market conditions in the first part of the year to shift nearly half its annual debt issuance needs already and the banks – which look like they will need recapitalization at some point – are well funded for now having also loaded up on the European Central Bank’s three-year liquidity splurge.

We also know Europe’s banks, too scared to invest elsewhere, are depositing 700-800 billion euros back at the ECB daily. If Madrid could engender a shift in confidence, some of that money could flow back into its bonds, particularly by Spanish banks.

Currency analysts are divided over whether U.S. criticism of Japan’s forex policy will change Tokyo’s currency stance. While some say it could raise the hurdle for further Japanese intervention, others think it might not have much impact. Rob Ryan, FX strategist at BNP Paribas in Singapore says the effect will be limited given uncertainty about the Japanese economy’s outlook and current levels of dollar/yen and cross/yen pairs.

“I think if they (Japanese authorities) feel they have to intervene, they will intervene,” Ryan says, adding that a dollar drop down to the “low 76s” might be enough to prompt further action from Japan.

The U.S. Treasury Department said in its semi-annual report on international exchange rate policies issued on Tuesday that the U.S. did not support Japan’s recent bouts of solo FX intervention, adding that they took place when volatility in dollar/yen was relatively low. USD/JPY was currently trading at Y77.98, not too far from a record low of Y75.311 hit on Oct. 31, when Japan conducted massive yen-selling intervention.

Anemic economic growth in the United States has sparked fears the country was entering a Japan-style “lost decade.” The comparison also has implications for government bond markets. Some traders see the U.S. Treasury market’s new, lower-yielding structure as eerily reminiscent of trading patterns seen in JGBs (Japanese government bonds). Says George Goncalves at Nomura:

There has been much debate since the start of the ’08 credit crisis over whether the US is turning into Japan and if so how to trade it. We have spent a fair deal of time over the last two years developing a framework for how US rates investors can leverage these insights to “Trading USTs like JGBs.” […] One thing is clear: momentum trading starts to wane and narrower ranges will become the norm in a low yielding world with the Fed on perma hold meanwhile a lack of alternative fixed income products is still forcing investors to buy USTs.

This does not mean that investors can remain permanently bullish on Treasuries, however, Goncalves warns.

A sharp recent drop in the Fed’s holdings of U.S. Treasuries for foreign central banks probably reflects the effort by many developing economies to stem rapid declines in their currencies, not some frightening move by the likes of China out of U.S. bonds. That’s the argument put forth by Marc Chandler at Brown Brothers Harriman, who notes the pullback of recent weeks appears to have been the most dramatic since the Asian financial crisis of the late 1990s.

His reasoning makes sense: a September spike in the U.S. dollar was accompanied by steep plunges in the exchange rates of many emerging economies. Still, Chandler remains puzzled as to why the selling accelerated to a hefty $21 billion even as the dollar reversed course in the last week:

This is the seventh consecutive weekly decline and over this period, custody holdings have fallen an average of about $12-$12.5 billion a week, making this past week quite large relative to trend. It likely reflects foreign central banks’ selling of Treasuries to intervene to support their currencies rather than a dumping of Treasuries to diversify reserves or as a protest to such low interest rates.

A guide at the “Japanese Experience” exhibition talks to Miim, the Karaoke pal robot, on the sidelines of the APEC meetings in Yokohama, Japan on Nov. 10. REUTERS/Yuriko Nakao

    Miim is one of the more popular delegates at the APEC meetings in Yokohama Japan. She sings. She dances. She tosses her shoulder length hair. She may not be able to spout an alphabet soup of APEC acronyms like the other Asia-Pacific delegates. But she’s still pretty lively. For a robot.

    This week’s meetings of the Asia-Pacific Economic Cooperation forum have been earnest and most comprehensive . Foreign and trade ministers issued a 20-page statement about all the things they talked about — a giant free trade zone, protectionism, the Doha round, easing restrictions on businesses, simplifying customs procedures, promoting green industries, cooperating on health and security, you name it. They also have been, and pardon my French here, excruciatingly dull. So far, the meetings and their stupefying statements have been a testimonial to Japan’s skill at stating the ambiguous. Call it the opaque meetings. Journalists from around the Pacific rim have been desperately trying to find news as the 21 APEC leaders gather for their annual pow-wow this weekend.

One of the most closely guarded secrets at the APEC summit in Japan’s port city of Yokohama this weekend is not what the Asia-Pacific leaders might say about currencies and global imbalances. No, that’s all going to be thrashed out at the G20 meeting Thursday and Friday in Seoul. The big topic of speculation here at the Pacifico Yokohama Convention Center is what the leaders will wear when they gather for the annual class photo that concludes the meetings.

U.S. President George W. Bush (L) and his Russian counterpart Vladimir Putin wear Chilean ponchos at APEC meeting  in Santiago in 2004. REUTERS

The last time Japan hosted the Asia-Pacific Economic Cooperation summit was 1995 in Osaka. There the leaders, apparently trying to depict the Japan Salaryman look, came out in business suits. Nobody remembers much about that APEC meeting, except that it took place in the magnificent, gold-embellished Osaka Castle. 

This week’s rehashing of European banking concerns – related variously to the Basel III impact on German banks, the ongoing morass re Anglo Irish Bank or any other scare story you want to exhume — provided the latest excuse for a global markets wobble as September kicked off. Yet, with some justified head-scratching over what really was new to the world this week as opposed to last week, price moves showed little conviction. Most losses were quickly recouped and decibel level of the commentariat, still frantically competing to warn you of the next disaster, toned down.

The world’s major sovereigns and banks have big financial problems, no doubt, and Europe more than its fair share. The rescues of the Spring did not provide a silver bullet and genuine repair will likely take a painfully-long time. But we’ve also had a lot of time to adequately discount these risks and the marketplace at large is already positioned extremely cautiously. That’s why the idea of sudden, blind panic on these long-running sagas seems just a little OTT – especially against a relatively stable, if bruised, economic backdrop. The bigger issue many investors are grappling with is the growing difficulty in making money in a hyper-cautious, low-growth environment. Ask Stanley Druckenmiller. If he threw in the towel because money-making conditions are just lousy, then you can be sure others see the same. Anecdotally at least, pressurised hedge funds – who faced rising redemptions through the summer – are ultra-cautious about open positions and seem quick to cut and run on even the slightest gain, long or short. (A bit like continually shouting ‘bank!’ on reaching £100 pounds on The Weakest Link!) Big institutional funds, meantime, are sufficiently uncertain about the market and economic direction that many are already keen to lock down for the remainder of the year and are hugging benchmarks to preserve whatever capital they have without resorting to zero-yielding cash or barely-more-attractive TBonds. U.S. midterms in November only add the caution. In short, it will take a pretty major positive or negative surprise to truly set these markets alight and there is every chance we won’t get a decisive one for some time.  We already have historically high vol and caution – but relative steady, unspectacular conditions for all that. The smart money may simply be tempted to buy or sell any hysterical extremes. Is may even be possible that some are tempted to foster a long-absent patience gene?

As to next week? There’s welter of new economic data to maybe add some flavour. The biggest potential movers are August China production and investment stats (now, oddly, being released Saturday rather than Monday) and then US retail sales, Philly Fed and German ZEW indices later in the week. On the issue du jour re European banks/sovereigns, an informal EU summit on Thursday provides the main set-piece – but BIS central bankers meeting in Basel this weekend and Spanish and Italian debt auctions next week may add their own spice.

Japan may well have looked like the odd-one-out after Monday’s news its economy grew 0.1 percent over the second quarter – about the feeblest expansion possible.

Europe’s big players were already in full swagger after posting growth second quarter growth that often exceeded predictions, and the U.S. economy – although clearly slowing – still expanded at a decent pace over the same period.

But looks are deceptive, especially from preliminary three-month snapshots of the rich-world economies, and Japan’s lethargy is probably still the rule, not the exception.

Mixed reaction from major European banks to appointment of Naoto Kan as new Japanese finance minister. ING is pretty scathing, saying the appointment sidesteps a process of change Japan must undertake to avoid further stagnation or a fate far worse.

“PM Hatoyama has appointed someone with no experience in economic management… Mr. Kan takes on the finance minister role without a well documented, deeply considered policy agenda. Here we rely on reports of positions he has taken in the Cabinet, and from public statements on economic management. These suggest his instincts are to pursue a stimulus strategy involving higher government spending; a weaker yen and ultra-loose monetary policy. Mr. Kan appears tone deaf to microeconomic reform or to the threats to financial stability posed by high public debt.”

The implication, ING says, confirms its worries about Japanese government bonds.