The Shizzle - Japan Bond Maths

The Shizzle Feb 13th, 2013

Why I’m writing:  'The BOJ said that they are increasing buying bonds, but they're also putting power into lowering interest rates. If the economy gets better, then l/t interest rates like a 10yr yield at less than 1% are unlikely. . . . . If we think about the future and if interest rates go up, then 67% in bonds does look harsh. We will review this soon.’   Takahiro Mitani, president of Japan’s Govt Pension Investment Fund (Y108tr in assets).

The evidence:  How much does Japan’s government depend on Bank of Japan, rather than private sector savings surpluses, buying the bonds it needs to float?

Yn tr	2012	2011	2010	2009
JGBs Issued	26.29	27.79	43.03	-10.63
FBs Issued	11.26	14.08	6.03	35.22
Total Supply	37.55	41.87	49.06	24.59
PSSS	15.77	27.53	49.74	13.94
Net BOJ Holdings	23.31	13.28	5.41	9.79
Total Demand	39.08	40.81	55.15	23.73
Demand – Supply	+1.53	-1.06	+6.09	-0.86

JGBs = Japanese Govt Bonds; FBs = Financial Bills; PSSS = Private Sector Savings Surplus; Net BOJ Holdings = Change in BOJ’s holding of JGBs, less changes in govt deposits

Conclusions:

·         In 2012, private sector savings surplus could have bought only 42% of the JGBs and FBs the government needed to sell. BOJ buying was the equivalent of 62.1%.
·         Between 2010 and 2012, annual debt issuance fell by 30.7%, net BOJ buying grew by 76.8%, and the private sector savings surplus shrank by 68.3%
·         Increasingly, Mitani-san’s portfolio, and the ability of PM Abe to finance expansion, depends pretty much solely on what BOJ decides to do next.
·         BOJ gov Shirakawa steps down on March 19^th.  Who his successor is really matters.

Follow up?  If you’d like further analysis, or to argue the toss about the conclusions, please email me on michael.taylor@coldwatereconomic.com

Shocks & Surprises Weekly FX Observations

Although nobody knows how to forecast fx movements with consistent success, a statistical approach to deviations from measured trends does at least allow us to say what is happening now, and when existing trends are under threat. Here are this week's observations, issued with the usual caveats - these are just empirical observations, if you use them to trade, and lose money, don't blame me:

Trend Breaks / New Trends
Australian Dollar: After spending two weeks on watch, A$ movements this week broke the strengthening trend, most probably establishing a new weakening trend.  Do not expect to see 0.96 again any time soon.

Strengthening Trends
US Dollar: Strengthening trend vs SDR in place since early January is still gathering momentum.
Euro: Strengthening trend in place since mid-Sept is not under threat, and is possibly accelerating. The current floor has risen to around 1.31.
Renminbi: The strengthening trend which has been in place since early Oct is still in place, but is perhaps morphing into stability vs the rising dollar. But for the Chinese New Year holidays, this would be a candidate for the Watch List.
Turkish Lira:  Strengthening trend in place since mid-Sept is still in place and not under challenge. The floor is now probably around 1.785.

Weakening Trends
Yen: There's no threat to the Yen's weakening, in place since mid-Dec.  The current ceiling of 84.03 is coming down rapidly. 
Sterling:  The weakening trend which has been in place since mid-Jan is strongly in place and possibly still accelerating. Sterling is not coming back to 1.60 to the dollar any time soon.
Gold: The new weakening against the dollar, in place since mid-December, is not under threat. The ceiling  has now probably come down to 1,701.
Commodities: Despite the run-up of the CRB Index during the last two months, this has not been sufficiently strong to reverse the weakening trend which has been in place since early Dec 2012.  Expect a short-term challenge to around 298.

A Week in Quotes

Global Growth
'It is not that discoveries no longer occur but that the rate has slowed. Without new knowledge, only derivative technologies are possible - and, however, important, they are incapable of sustaining the sorts of economic growth rates the world has enjoyed since the coming of the industrial revolution.' Andre Geim, Nobel Prize winner for his work on graphene, writing in the FT.

Japan Bond Yields

'If the economy gets better, then long term interest rates like a 10 year yield at less than 1% are unlikely. So 'If we think about the future and if interest rates go up, then 67% in bonds does look harsh. We will review this soon. We will being discussions for this in April-to-May. Any changes to our portfolio could begin at the end of the next fiscal year.'  Takahiro Mitani, President of the Government Pension Investment Fund, with Y108tr in assets to manage.

Apple and Unions in China 

'The position of chairman and 20 committee members of the Foxconn Federation of Labour Unions Committee will be determined through elections once every five years through an anonymous ballot voting process.'  Foxconn explains how its Chinese workers will choose replacements for the  c18,000 union committees whose terms expire this year and next. 

Apple and its Cash

'It has a sort of mentality of a depression. In other words, people who have gone through traumas  - and Apple has gone through a couple traumas in its history - they sometimes fell like they can never have enough cash.'  David Einhorn, of Greenlight Capital, urging Apple to disgorge more of its $137bn cash to investors. 

Fiscal Problems: Europe and US

'It's ridiculous sometimes when you look at the kinds of difference we're negotiating: a few billion over seven years. . . '  Luxembourg PM Jean-Claude Juncker on EU budget negotiations.

'Deficits are projected to increase later in the coming decade because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt.'  Expecting publicly-held federal debt to reach 77% for 2023, 'Such a large debt would increase the risk of a financial crisis, during which investors would lose so much confidence in the government's ability to manage its budget that the government would be unable to borrow at affordable rate.' US Congressional Budget Office.

Shocks & Surprises Weekly Espresso

This week's issue of the Shocks & Surprises Espresso takes a look at the implications of three sets of data:

• US personal income, which rose 2.6% mom in December
• German terms of trade for December, and their implications for the Eurozone
• Japan's 4.8% yoy rise in construction orders in December, including the 52.7% yoy jump in national government orders. 

In each case, I think there are things to be learned by looking at them in a little more detail. The Espresso is delivered in email form, and if you'd like to take a look, email me at michael.taylor@coldwatereconomics.com.

Shocks & Surprises Weekly FX Observations

Last week I explained the methodology behind Shocks & Surprises approach to currencies (here), but the caveats are worth repeating.  No-one knows how to forecast currencies with consistent success, and the ex-post factor economic rationalizations for specific currency movements are all as good, or bad, as each other. All I am trying to do in these pieces is identify current trends and likely changes in them in a way which is consistent, which I've been using for years, and has at least some modest statistical backing. If you trade off them, and lose, it's your own lookout.

Strengthening Trends
US Dollar: continues to strengthen against the SDR as it has since early June, and that trend is not under threat.
The Euro: continues the strengthening trend against the dollar that has been in place since mid-Sept, and is possibly now accelerating.  Currently it's likely floor is around 1.305.
Rmb: The current strengthening trend has been in place since early Oct, and whilst mild, is not under threat.

Weakening Trends
Sterling:  The emergence of the weakening trend in mid-January is strongly in place, and is possibly accelerating. Sterling isn't going to see 1.60 to the dollar again any time soon.
Yen:  There's no threat to the weakening trend that has been in place since mid-December. The current ceiling is 83.2 (ie, it would be a major surprise if it reached this leve), and is rising quickly.
Gold: The new trend of weakening against the dollar is not under threat. The current ceiling is 1,706 an ounce, and falling.

On Watch
Australian Dollar: I put this on watch last week, and it remains there. Whilst it seems clear that the currency no longer has a strengthening trend, it is too early to say whether its replacement will be stability or weakness.

A Week in Quotes

Eurozone - Two Views
'Last year there was a very tense mood here in Davos. This year I think we are seeing sentinment moving from stabilization to recovery, and that means I should get a chance to do some cross-country skiing.'  Olli Rehn, EU Economic and Monetary Affairs Commissioner.

'The ECB has already provided extra refinancing credit to the tune of Eu900bn to commercial banks in countries worst hit during the crisis, as measure by its payment system known as Target. These banks have in turn provided the ECB with low-quality collateral with arguably insufficient risk deductions. The ECB is now in the same position as private investors. It is guaranteeing the survival of banks loaded with toxic real estate loans and government credit. So the tranquillity is artificial'.

And . . . 'The proposal for bank resolution is not a firewall but a 'fire channel' that will enable the flames of the debt crisis to burn through to the rest of European government budgets'.

Finally  . . . 'Asset ownership in bank equity and bank debt trends to be extremely concentrated among the richest households in every country. Not bailing-in these households amounts to a gigantic negative wealth tax to the benefit of wealthy individuals worldwide, at the expense of Europe's taxpayers, social transfer recipients and pensioners'. Hans-Werner Sinn, of the Ifo Institute, writes in the FT.

China's Regulators on Wealth Management Products
'The banking industry's wealth management business has channelled funds that might otherwise flow into high-interest underground loans, illegal fundraising, and commodity speculation and has upheld financial stability'.  China Banking Regulatory Commission's Yan Qingmin. 

'Ninety nine percent of wealth-management products arae normal products, approved by the China Banking Regulatory Commission. Maybe there are a small number that are problematic but that's not a risk to the banking sector.'  Fang Xinghai, DG of Shanghai financial watchdog.

Japan,  FX Policies and Politics
'Europe is in no position to criticize Japan. Europe has brought about a prolonged weakness of the euro as a result of their own policies, whilst Japan has supported Europe through purchases of bonds.'  Yasutoshi Nishimura, Dep Economy Minister.
'To survive and prosper Japan needs to participate in international trade without being encumbered with isolationist ultra-nationalists. Like horses in blinders, they are unable to see beyond their noses.' Sir Hugh Cortazzi, former British ambassador to Japan, and long-standing friend of Japan, worrying about  having nationalist Harkubun Shimomura as Education Minister.

Australia Elections 
'Australia now faces an eight-month election campaign which will mean that some significant investment decisions by business will be put on hold.'  Innes Willcox, CEO of the Australian Industry Group comments on the vote to fix elections for the lower house and half the Senate for Sept 14th.

Taiwan - The Pension Problem Put in Context
'The pension system time bomb won't explode during my term . . . However, the train will definitely fall off the cliff if we don't start building a bridge right now.' President Ma Ying-jeou explains.

A Shocks & Surprises Approach to Currencies

Currency Conclusions

Strengthing Trends

• US Dollar: Since early January, the dollar has been on a strengthening trend vs the SDR, and that trend is not currently under threat. 
• Euro: The current strengthening trend has been in place since mid-September, and is not under threat.
• Rmb: The current strengthening trend has been in place since early October 2012, and is not under threat. 

Weakening Trends

• Yen: The weakening trend has been in place since mid-December and is not under threat. 
• Sterling: A new weakening trend emerged in mid-January, and is strongly in place. 
• Gold: Reflecting the dollar's strength, since early January gold has been on weakening trend, and that trend is not under threat.

On Watch

• Australian Dollar: The strengthening trend which was in place since the second week of January is now under threat. 

Argument & Methodology
Forecasting exchange range is for mugs. Despite it being a lucratively-rewarded profession, no-one knows how to forecast currencies with near-certainty or accuracy, and for good reasons. The first good reason is that the spot price will always reflect a fluctuating arbitrage between short-term cashflows and longer-term balance sheet necessities, and both sides of that arbitrage are fundamentally in the process  of new discovery, as is the appropriate arbitrage between them. For example, that current cashflows may support the Yen or the Euro can be a situation which can quite easily co-exist - for decades - with a situation in which balance sheet considerations look distinctly unappetising.

The second reason is simpler: for major currencies, fx markets are probably the nearest thing we have to perfect competition,  the logical extension of which is that your explanation is likely to be just as good, or bad, as mine, no matter how hard you (or I) work at it.  Competition, after all, exists to discover information which can be discovered in no other way.

But the itch, the desire to say something useful about currencies, remains. Even working day since Friday December 1st 1995, I have collected OANDAs' tick-averaged fx for all major Asian and European currencies, and consequently have a reasonable database from which to make observations. In practice I use them not to forecast, but rather construct from them rules-of-thumb about the state of individual currencies: are they stable, strengthening or weakening, and at what point to they look like breaking trend?    The rule for this is simple: I track moving averages and standard deviations measured from the point of inflection in 90-day trends. (Each day, the average and standard deviation will change as the trend is extended - typically as the trend lengthens, the average deviation from it will fall, whilst the standard deviation grows). Historically I find that when daily prices are more than two standard deviations away from that trend, a trend inflection usually follows.  

What I am attempting to do is simple and limited: I am trying to accurately identify current trends, and identify plausible threats to them.   I intend to publish my conclusions every Monday.