This Day On The Street
Continue to site
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Japanese Bonds Are Key to Abenomics Watch

NEW YORK ( TheStreet) -- Following are some numbers on Japanese public debt, compiled from various reports at Japan's Ministry of Finance:

Total debt outstanding: about 1 quadrillion yen, of which 821 trillion yen consists of bonds as of March 31 (the end of the 2012 fiscal year). For those of us without Ph.D.s in large numbers, 1 quadrillion is 1 followed by 15 zeros. Budgeted bond issuance for fiscal 2013 is 170 trillion yen. A reasonable estimate would be 1.2 quadrillion yen in total debt by the end of fiscal 2013.

Total national debt service (interest payment): 22 trillion yen, or 24% of government revenue (90 trillion yen), as of fiscal 2012.

Given that the average maturity of outstanding Japanese debt is about eight years, a 1% increase in the yield of eight-year Japanese government bonds translates into 1.7 trillion yen in extra cost in new issuance for fiscal 2013, and an 8% capital loss (or 80 trillion) for bondholders, 69% of which are domestic banks, insurance companies and pension funds.

The yield on the eight-year JGB increased from a recent low of 0.305% on April 4 to 0.797% on May 28. That's a mark-to-market loss of about 40 trillion yen for bondholders in less than two months.

(One way to invest in Japanese government debt is the PowerShares Japanese Government Bond Futures ETN (JGBL), but be aware of its very low volume.)

The increase in JGB yields has been quite furious, as you can see from the chart below. Note that the increase in the immediate aftermath of earthquake/tsunami/nuclear-meltdown disaster of March 2011 was buried in the noise in the chart.

More important than the fast rise is that this is happening after the Bank of Japan announced unprecedented qualitative and quantitative easing, as part of three-arrow Abenomics, including an estimated JGB purchases of 80 trillion-plus yen.

JGB Eight-Year, 15-Year and 30-Year Yields From Jan. 1, 2008 to Now

Chart by Bo Peng. Data courtesy of Japan's Ministry of Finance

When the market doesn't want to front-run you, despite your public announcements over every loudspeaker in every corner of the globe, you ought to be worried.

Why doesn't the market want to front-run the Bank of Japan? There are two possible reasons:
  1. Inflation expectations are higher. This would be exactly what the Bank of Japan wants. Unfortunately, as Goldman Sachs research recently showed (via ZeroHedge), the inflation expectation remains mostly flat, at less than 1% out to 2016 after taking into account the planned consumption tax increase in April 2014.
  2. The market is worried about the risk of BoJ losing control of the yield curve. This is nonsensical at first glance: They'd just print more money and buy up JGBs. But in reality there's another limit to how much BoJ can buy: the repo market. As recently happened in the U.S., banks may run out of Treasuries as collateral if the central bank monetizes too much. This severely disrupts banking and money market operations.

Unless the Bank of Japan manages to stop the yield surge soon, a positive feedback loop may kick in and push things out of control: The major JGB holders, Japanese banks, insurance companies, and pension funds, would be hit with a triple whammy of:
  1. massive mark-to-market losses,
  2. sharply increased risk reserve requirements heavily dependent on JGB volatility, and
  3. collateral squeeze.

If/when forced selling starts, it would become a chain reaction.

And if the yen ( CurrencyShares Japanese Yen Trust ETF (FXY)) surges at the same time, it could only mean one thing: Japanese repatriation of its massive overseas investment to fight fire at home, as happened following the 2011 earthquake. This could make the Lehman moment seem petty in comparison.

I'm not saying this would happen soon. Systems with such great nonlinearity are extremely hard to predict and particularly difficult to time. The point is that the situation is very unstable and warrants close attention.

If you're in the market in any asset class (but especially Japanese equities, e.g., iShares MSCI Japan Index ETF (EWJ)) without adequate hedge in terms of big adverse movements or volatility, you'd better be very nimble if/when it comes.

Or, if you're prepared to take some pain, potentially a lot for a long time, follow Kyle Bass and be early on the widow-maker trade, in exchange for the potential reward of being early on the biggest trade of the century.

At the time of publication, Peng had no positions in securities mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
SYM TRADE IT LAST %CHG
EWJ $11.92 1.20%
FXY $80.61 -0.06%
JGBL $21.61 0.09%
AAPL $111.63 -0.63%
FB $89.15 -0.82%

Markets

Chart of I:DJI
DOW 16,486.47 +135.09 0.83%
S&P 500 1,966.48 +17.62 0.90%
NASDAQ 4,780.5660 +30.5870 0.64%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs