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Displaced JGB Investors

Marc To Market's picture




 

(written with my Tokyo-based colleague Masashi Murata)

What the Bank of Japan is doing is not unprecedented. Rather it is the pace of its asset purchases that is striking. It will do in two years what the Federal Reserve took five years in terms of balance sheet expansion. It will boost its monetary base by around $1.335 trillion by the end of next year. It will be purchasing about 70% of new JGB issuance. The Ministry of Finance issuance and BOJ intended purchases do not appear to align very well and this appears to be impacting the curve and secondary markets.

One of the most important issues for the capital markets is the response by the displaced investors. It is well appreciated that Japan’s debt is largely financed domestically. There are three key holders of JGBs banks (~41%), insurers (~22%) and pensions (12%). Households account for about 4% and foreign investors 8%.

This kind of quantitative easing, different from the targeting of interest rates, has been tried before in Japan—April 2001-March 2006. Banks increased their holdings of non-yen securities as a percentage of their portfolios (which include Uridashi bonds) by 1.4% and life insurers and pensions by 3.6%.

If this was repeated now, it could lead to the portfolio investment outflow of JPY45 trillion (~$450 bln). The market response in the days since the BOJ’s announcement seems to be largely in anticipation of such flows.  While it is a dynamic situation, and institutional investors may take some time to adjust their strategies, some diversification may have already taken place.

That the BOJ was going to become more aggressive due to new leadership or a change in its mandate has been long telegraphed. The real unknown was when not if. In the past 18 months, institutional investors have increased their foreign asset weighting of their portfolios; banks by 1.5% and life insurers and pensions by 0.75%.

In some ways, the choice faced by the institutional investors reminds one of the rant by a Woody Allen character complaining about a restaurant: “The food was poor and the portions small”. Yields in the main core bond markets that have the liquidity and transparency Japanese investors prefer, are low—near record lows. And the quality has deteriorated. Low yields for weakening credits, does not strike one as an attractive bargain.

Household investors face the same dilemma. The yen can buy 25% less foreign bonds than it could a year ago. The kind of assets they may be tempted to buy have increased in price. Meanwhile, the Nikkei has exploded. For the first time in years, the domestic equity market is exciting, up around 50% since it became clear to many that Abe was going to become prime minister.

The recent weekly MOF portfolio flow data illustrates our concern that the market may be exaggerating the what the displaced domestic JGB investor is doing.  The data released earlier today covers the week through last Friday.  Japanese investors sold JPY1.145 trillion of foreign bonds.  This is the most in a year.  It was the fourth consecutive week that Japanese investors sold foreign bonds.  During that span it sold JPY2.235 trillion.  Moreover, in the 14 weeks of data this year, Japanese investors have been buyers of foreign bonds only three times.

What many observers do not seem to be giving sufficient due to is that the weaker yen may encourage profit-taking on the large stock of foreign investment that Japanese have already accumulated and the appeal of the local stock market. 

Meanwhile, foreign investors prodigious buyers of Japanese equities, buying another JPY869 bln in the latest week.  They have been buyers in 19 of the past 20 weeks and have bought JPY6.5 trillion over this period.  This overstates the portfolio inflows into Japan as foreign investors trimmed their JGB holdings, but have still bought a net JPY4.82 trillion of Japanese financial assets (excluding bills) over the past 20 weeks.

What has often happened in the past is that the money coming into Japan from its current account surplus and foreign investment was not offset by Japanese demand for foreign assets, foreign direct investment and speculative flows.  When the private sector struggled to re-cycle the surplus, the Ministry of Finance often has felt compelled to authorize BOJ intervention to fill the breech.  The last time it intervened was in late October 2011, when it sold $100 bln worth of yen in a single day.   Appreciating the fluidity of the situation and that trade balance has swung into deficit (through the investment income surplus remains substantial), and that Japanese corporates appear to be stepping up their foreign direct investment, we are concerned that the recycling problem may once again surface.

 

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Thu, 04/11/2013 - 11:06 | 3436376 GolfHatesMe
GolfHatesMe's picture

I have seen JGB a few times when Jerry Garcia was alive.  Are they still touring?

Thu, 04/11/2013 - 10:06 | 3436059 Orly
Orly's picture

The question of future movements in the yen will absolutely rely on one major factor and that is the reaction it makes to any risk-off scenario.

SPX and global equities are ramping on fumes and everyone knows it. The massive wall of worry that they are walking in the ether probably has most traders spooked, yet the market sets daily records on lighter than light volume.

If and when that false altitude is removed, one way or another, major shifts into safe-haven holdings will be the order of the day.  How does the yen react to falling yields on US bonds?  Lately, the yen has acted as a safe-haven currency to the detriment of the US dollar.

Does that still hold, given planned changes in Japanese asset allocation? Does that change now because the Japanese are running trade deficits for the first time in years in a pattern that looks to continue for the foreseeable future?

It seems the more things change, the more they stay the same.  But if risk is on, will the yen be able to absorb those kinds of inflows, given the fact that asset managers have already stepped to the left?  They would be caught off-balance and movement into yen could knock them over.

Needless to say, trading yen has one have their head on a swivel.  The real question here is whether things do stay the same, after all.  Stay nimble and open to changes.

In the meantime, after same-old US Initial Claims, watch for the major big number to be breached: USDJPY 100.  That wil be the prize.  What happens after that will be anyone's guess- but one thing is for sure: once the yen gets going in one direction either way, it may be very difficult to stop.

:D

Thu, 04/11/2013 - 09:21 | 3435888 eddiebe
eddiebe's picture

the real mystery here is why all that 'displaced'money isnt going into gold.

Thu, 04/11/2013 - 10:01 | 3436043 hooligan2009
hooligan2009's picture

just wait til bitcoin discovers darkpool technology!

Thu, 04/11/2013 - 09:14 | 3435863 MythicalFish
MythicalFish's picture

Hats off to Tokyo-based Japanese colleagues who quote Woody Allen rants!

Thu, 04/11/2013 - 09:04 | 3435822 disabledvet
disabledvet's picture

I can see the yen moving back towards it's highs as well. We all know the problem with this "strategy" as it was tried by the USA in the 70's to deal with the "twin towers" of both Federal trade and budget deficits. Needless to say 40 years on and "those twin towers still remain." this whole "banking fetish" with Dee Atorities never ends well. I think Japan understands this and will do what it can to keep the yen from collapsing. What that means exactly is hard to figure right now. "faster, better, cheaper" does come to mind however...and all that foreign investment there says to me "growth will not be picking up in the USA anytime soon."

Thu, 04/11/2013 - 08:50 | 3435780 Yellowhoard
Yellowhoard's picture

I'm surprised that Japan isn't reflating more quickly.

This is a no brainer trade.

Borrow Yen, buy stocks or non Japanese debt with as much leverage as you are allowed.

Steal underwear.

Profit.

Thu, 04/11/2013 - 08:42 | 3435753 hooligan2009
hooligan2009's picture

hmmm...this is counter-intuitive..an injection of the size of the planned bond purchases must displace holders of JGB's..it does not seem possible that the only recipient of the cash proceeds is the Japanese equity market.

one must therefore question the validity of the MoF data.

we all know that derivatives markets are something of the order of 15-20 times the size of the physical markets. we also know that japanese investors (banks, corporations, high net worth individuals are not stupid).

this implies to me that the MoF is not monitoring the actual risk moving around the globe as the result of its actions and that the physical flows paint a distorted picture.

similarly, what it does not seem to show is the size of the yen forward market. this is a quazi derivative and, I suspect, is ignored totally by MoF statistics.

Thu, 04/11/2013 - 09:31 | 3435921 suteibu
suteibu's picture

All data coming from the Japanese government is biased toward creating confidence - or, better stated, maintaining "hope" among the shrinking consumer class that the government knows what it is doing.  It is doubtful that information is not monitored as those banks, corporations and high net worth individuals would want that information.  Instead, it is simply not factored into the public data.  As an example, does anyone really believe that the sub-5% unemployment data - when nearly half of the workforce consists of less than full-time employees - reflects the true nature of the labor force and economy?  People complain about the Chinese manipulating their economic data...they learned how to do it from the Japanese.

So, any financial analyst who uses the government data-set as their basis for analysis is treading on thin ice.  What Abe/Kuroda are doing should not cause concern, it should raise a big red flag with a flashing red light on top and an ear-piercing siren.

Thu, 04/11/2013 - 09:56 | 3436021 hooligan2009
hooligan2009's picture

i look forward to more of your insight in future..it is difficult for a foreigner to even pretend to understand what is going on..we have the negative press, zombie banks infecting zombie corporates, 6758 being a foreign owned company now, companies employing people to sit around and do nothing all day, an even more chauvinistic attitude to women than the US, UK and France, rock and rollers in downtown tokyo, cublicle living, massive car recalls, 

but what we don't have here is 

what is left behind after the crap coming from government and the central bank is removed, i.e. what is the "real" economy doing and how much innovation and growth is being removed from the economy because of keynesian type policies or "how soon before the value of a zero perpetual borrowing cost is seen for what it is..zero..and nobody wants JGB's (or Treasuries or Bunds or Gilts).

thanks again

Thu, 04/11/2013 - 10:31 | 3436183 suteibu
suteibu's picture

Thanks.  It is a sad thing to see that the Japanese people are not well-served by their corrupt political and bureaucratic classes who would rather sell out the nation than lose their status.  I see some people waking up to the situation but it only scares them into withdrawal and depression.  An entire generation of Japanese youth have reached adulthood knowing nothing but decline with little hope or inspiration that the future will be better.  It is reflected in the social data; poverty, birthrate, marriage, divorce, single-parent households, etc.  It is difficult to imagine a more effective destruction of a proud, hard-working, family-oriented society even if it had been planned.

Thu, 04/11/2013 - 10:56 | 3436297 hooligan2009
hooligan2009's picture

what is left is a structured, non-criminal or non-violent way to simply sack the government and repudiate all debt..system reset..it is clear that banks should be nationalized, they are a utility when the government sector is so dominant and companies can only limp along because of family loyalties, sense of honor etc..(cant lay off a loyal worker and, instead, wait forever for better times) 

the lost generation is present in the west also..or rather..around 15% -20% of the population has to be paid with benefits to be non-violent or non-criminal.

i am minded that socialism removes all possibility of vision..simply "sucks the fun" out of life in general. the communistic, centrally planned, state system is becoming more and more prevalent in the west. people have no concept of how things could be, if only they were "free".

Thu, 04/11/2013 - 11:27 | 3436538 suteibu
suteibu's picture

I could not agree more with your comment.  In many ways the Cold War was wasted, the socialist/central planning aspects of communism are fully entrenched in Japan and Europe and becoming more prevalent in the US.  However, I believe that, above all others, the Japanese society can mount a resistance with the right inspiration.

Thu, 04/11/2013 - 10:44 | 3436254 Orly
Orly's picture

Sounds like US government operations against blacks after the Civil War that continues to this day.

With a homogenous society like Japan, though, it would be difficult to isolate a single segment of the population without anyone else noticing. The Feds pulled it off in style.

:/

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