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Global Briefing: More Bad News in Japan

Markets are getting over the Fed's decision yesterday.

Bonds are mostly weaker, stocks mixed and the dollar stronger this morning.

While it is easy to attribute the price action to yesterday's

decision by the

Federal Reserve

to adopt a tighter bias, the real story is more complicated.

Japanese government bonds put in one of their worst showings in the past month

, but the market was responding to domestic developments more than the subtle shift in the Fed's stance. In particular, reports suggest the ruling Liberal Democrats have begun discussing plans for another 10 trillion-yen ($81 billion) supplemental budget. Under consideration are increased public works spending, an increase in subsidies for the rising number of unemployed, and new loans to small businesses. This comes on the heels of the


reversing its previous forecast that projected 0.2% expansion of the Japanese economy this year. In its new forecasts, it sees the world's second-largest economy contracting by 0.9%.

The yield on Japan's 10-year benchmark bond rose 5 basis points to 1.325% and the yield curve, as measured by the spread between the two- and 10-year yields, rose 6 basis points to 128; it is now 10 basis points wider than it was a week ago. The


fell for the fifth consecutive session, losing 1.5%. Foreign and domestic life insurers were reportedly the featured sellers.

News from Japan went from bad to worse.

Reports revealed that under new disclosure laws that went into effect as of the end of March, Japan's 15 major banks' problem loans stood at 20.19 trillion yen (roughly $164 billion), which represents a 6.3 trillion-yen increase from what was disclosed under the previous rules. Japan's woes are not limited to the financial sector. The top five carmakers slashed domestic production in April, led by a 20% cut by


and a 19% cutback at



. New car sales, excluding minivehicles, fell 11% in April on a year-over-year basis, marking the 25th consecutive monthly decline from year-ago levels.

Elsewhere, New Zealand's central bank warned that global growth is not sufficiently strong to justify the strength of the New Zealand dollar, which is among strongest currencies this year. The bank indicated that if global economic conditions don't improve, or if commodity prices rise further, it might have to reduce rates later this year. The market took the hint and drove the New Zealand dollar down more than a cent from yesterday's highs, which helped drag the Australian dollar lower as well.

Europe also is struggling.

Bond markets are generally lower, with the yield on the German 10-year benchmark 3 basis points higher. Nevertheless European bonds have fared better than U.S. bonds and this has resulted in a continued widening of spreads. The spread between U.S. and German 10-year bonds is the widest in more than 10 years.

The widening interest rate differentials reflect the contrasting economic performances. In its monthly report released yesterday after the European markets closed, the

European Central Bank

acknowledged that the signs of economic recovery, outside some rebound in business confidence, remain scarce. It also said that while the increase in oil prices may push up inflation measures, general price stability is not jeopardized. Meanwhile, European bourses were slipping after posting minor gains in the early going.

Note that the minutes from the Bank of England's May monetary policy meeting indicated a close vote to keep rates unchanged.

The 5-4 vote raises the prospect of a rate cut next month. The effect of this was blunted by news of an unexpected decline in British unemployment. The unemployment queues fell by 17,400 in April, defying market expectations for a 5,000-job rise. The March series was revised to reflect a 4,300-job decline in unemployment, rather than a 2,000-job increase that was initially reported. Unemployment remains at a 19-year low of 4.5%.

The dollar rebounded from yesterday's lows shot through the 124-yen area

. This remains a key level for the greenback. A convincing move above there would allow it to move into the area in which it collapsed from in the middle of last October. The next target would be around 130 yen. The euro tested the upper end of its trading range against the dollar yesterday, a little above $1.07. Today it's slipping toward the lower end of its 1-cent range, which comes in a little above the $1.06 level. It is difficult to see a significant move in either direction, leaving continued range-trading the most likely near-term scenario. Over the slightly longer term, I'm still inclined to look for a move toward the $1.0325 area, roughly where the euro was theoretically trading a year ago when the key decisions on monetary union were made.

The U.S. reports its March trade balance tomorrow. Most forecasts call for a modest narrowing of the deficit from the $19.4 billion shortfall posted in February. Federal Reserve Chairman

Alan Greenspan

warned recently that the trade deficit was a threat to the strength of the U.S. economy. I suggest this is the most old world thinking from the man who has been among highest-ranking sympathizers for the New Paradigm. The U.S. trade deficit is among the least understood economic reports. Consider that nearly 40% of U.S. imports are from U.S. businesses abroad. The trade deficit does not reflect the competitiveness of the U.S. economy as it once did. It now reflects the integration of the global production by U.S. companies.

Also, look at what the U.S. is importing.

Nearly two-thirds of the growth in U.S. imports over the past five years is accounted for by capital goods. Capital goods generate their own income stream and are significantly different than consumer goods in this respect. The increase in capital goods imports contributes to making the U.S. economy more productive and dynamic.

Look at how the deficit is being financed. Long-term direct investment rather than short-term hot capital are financing an increasing share of the U.S. external imbalance. This suggests that financing the deficit is on more stable footing. In part this reflects the fact that the U.S. uses capital more efficiently and productively than other countries. According to one study, for the same level of risk, the return on equity investment in the U.S. generates a 400-basis-point higher return than Germany, for example. Lastly, the current-account surpluses enjoyed by Japan and the EU are not a sign of their economic strengths but rather their weakness.

Some times you eat the bear and some times the bear eats you. I was dinner

yesterday, having warned that the Mexican peso would weaken and interest rates would rise at the government's auction. Dead wrong. The peso strengthened and interest rates fell. The yield on the 28-day cetes (T-bills) fell 33 basis points to 19.75%, the lowest rate since last June. Some talk in the market suggested that because the Mexican economy is increasingly integrated with the U.S., its markets are seen as a regional safe haven. Flows out of Argentina and Brazil may be being parked in Mexico.

Reports suggest that foreign investors owned a record 41% of the value of Mexico's Bolsa in April, up from 37% in March.

Note that Mexico also reported weaker first-quarter growth than expected yesterday. First-quarter GDP rose 1.9%, its slowest pace in three years. Expectations were that the economy expanded by more than 2%, following 2.6% growth in the fourth quarter.

High interest rates, which averaged 27.8% in the first quarter, continue to cramp domestic sales. The slowdown was most evident in the industrial sector which grew at a 1.8% annualized rate, half the rate seen in the previous quarter.

Finally, note that Brazil's central bank holds its policymaking meeting today and given the change in the Fed's bias, a rate cut -- though still desirable -- is not as sure a thing as it was a week ago.

Marc Chandler is an independent global markets strategist who writes daily for At the time of publication, he held no positions in the stocks, currencies or instruments discussed in this column, although holdings can change at any time. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

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