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Goldman Reinforces The Bass-Grice Japan Inflation Thesis: Issues 6th Top Trade Of 2011 - Buy 5 Year JPY Inflation Swaps

Tyler Durden's picture


The two most prominent defenders of the Japan-inflation theme, Dylan Grice and Kyle Bass, have just gotten a key reinforcement:Goldman Sachs. Last night, Goldman released its much anticipated 6th trade, to its roster of top trades for 2011. It just happens to be a bet on Japanese inflation. Which, however, begs the question - is this one of those trades where Goldman is, naturally, on the other side and is selling Japan inflation to clients. If the performance of the Squid's Top 10 trades for 2010 is any indication, we would be very cautious, although the fundamentals presented previously by Grice and Bass certainly present a very convincing case for why Tokyo may soon have no choice but go schizo with money printing (all over again), only this time with the gusto previously exhibited only by such monetary madmen as von Havenstein, Gono, Mugabe and, naturally, von Bernankestein.

From Goldman Sachs Global Markets:

Trade Update: Recommended Top Trade #6: Long 5-yr JPY Inflation Swaps

Over the past several months the major inflation markets have moved to price in a significant acceleration in headline inflation, reflecting higher commodity-led inflation, as well as a gradual erosion of spare capacity. By contrast, prospects for higher inflation are still under-appreciated in Japan, as Fiona Lake argued recently. In inflation markets, Japanese inflation swaps have been clear laggards relative to their peers.

Granted, the re-basing of the Japanese CPI, due this August, should shave around 40-50bp off trailing inflation. But this one-off adjustment is most likely in the price already and an upside surprise to this estimate would likely have little effect on intermediate inflation. Moreover, consumption tax hikes in the coming years are not in the price, yet the probability of such a move is non-zero.

From a valuation standpoint, intermediate inflation swaps appear to be fairly valued, as is the case for most of the other G4 inflation markets. However, our analysis suggests a rapid increase in equilibrium inflation swap rates from -10bp currently to around +50bp in Q3. This is based on a regression analysis, which suggests that inflation expectations and short-dated inflation swaps do not fully reflect the non-core inflation pressure in the pipeline.

Moreover, a  Z-score analysis across the G4 markets suggests that intermediate JPY inflation swaps are lagging their peers: specifically, JPY inflation swaps are around -4.0 standard deviations below the pre-crisis ‘norm’, compared with Euroland and US swaps, which are - 1.5, -1.0 below the 'norm' respectively.

On this basis, we would recommend holding 5-yr JPY inflation swaps as a strategic trade for this year. Currently at -13bp, we see them rising to around 40bp by Q3. We expect the cost of carry to be flat over the coming 6-months and to rise thereafter.


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Wed, 02/16/2011 - 13:54 | Link to Comment boooyaaaah
boooyaaaah's picture

ZH silence on Wisconsin is deafening

How do we get out of debt??

Stop government spending!!!

Then Riots

Then what

Wed, 02/16/2011 - 14:50 | Link to Comment thedrickster
thedrickster's picture

Send the unemployed public sector parasites to Chicago, population replacement.

Wed, 02/16/2011 - 14:07 | Link to Comment irishlink
irishlink's picture

Is this the only way the can deflect attention from the American inglation scenario. Clever. Never see whats under ones nose.

Wed, 02/16/2011 - 14:08 | Link to Comment mcguire
mcguire's picture

"Which, however, begs the question - is this one of those trades where Goldman is, naturally, on the other side and is selling Japan inflation to clients."

-selling 5 year japanese inflation swaps seems esoteric enough that it would not qualify as a plan to 'con' clients/lemmings to pile into the trade...

Wed, 02/16/2011 - 14:09 | Link to Comment mcguire
mcguire's picture

selling japanese government bonds is the cheapest way to get poker chips.

Wed, 02/16/2011 - 14:13 | Link to Comment Bruno the Bear
Bruno the Bear's picture

Who is Gono?

Wed, 02/16/2011 - 14:26 | Link to Comment mcguire
mcguire's picture

dr. gono, zimbabwe

Wed, 02/16/2011 - 14:26 | Link to Comment the rookie cynic
the rookie cynic's picture

The squid's tentacles are befuddling as they are deadly: one appendage shakes your hand with a friendly grip, while the other sinks a knife into your back. Don't ask me about the other don't want to know.

Wed, 02/16/2011 - 14:35 | Link to Comment 6 String
6 String's picture

Somebody, in english, explain to me how i can short JGB's and/or corporates in Japan.

Puh-please. I am begging.

Wed, 02/16/2011 - 15:23 | Link to Comment CrankyOldCreditGuy
CrankyOldCreditGuy's picture

+1.  I have been trying to figure out how to put on a trade in my personal account as well.  any ideas other than YCS would be greatly appreciated.  thanks.

Wed, 02/16/2011 - 19:23 | Link to Comment Geoff-UK
Geoff-UK's picture

GS says I should bet on Japanese inflation.  But I should do the opposite of what GS says.  Unless they're telling the truth, in which case I SHOULD do what GS says.  Unless they know I'm on to their trick of occasionally telling the truth, in which case I should NOT do what GS says.


Or I could stand on the sidelines with some PMs and watch the show.  I heard you should never bet against a Sicilian (Bernakeioli) when death is on the line.

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