Planet Yelnick

Is Japan Signaling the Beginning of the End?

Since The Bernank spoke last week, the Japan markets have been in turmoil. Stocks have fallen over 12% in just a few days, and, most troubling, bond rates have risen sharply. See chart, courtesy Zerohedge:

Is the Bank of Japan losing control over rates? The theory of QE is that the central bank can manage rates down by purchasing bonds, but the bond vigilantes in Japan are pushing back.

In the US the fear is that the Fed will be unable to taper off QE. The Bernank's remarks last week were of a taper, and yet in the US the 10 year has spiked above 2%. There is a concern that if rates go above 2.2-2.25%, the biond portfolios will begin to rotate their mix of long and short bonds, essentially causing a spike in the ten-year which might shoot it to 2.5% - the so-called Bond Convexity. If this happens, expect the Fed to stop the taper and jump back in with (say) two months of QE in one month, to drive rates down. 

This would be quite a good buying opportunity of the ten year. It also may signal that even the Fed will face issues in trying to taper and avoid losing control over rates. 

Japan's QE is Exporting Deflation

Japan's effort at super QE is likely to export its deflation to trading partners. John Mauldin has a long a analysis of this in his current newsletter. Our occasional guestblogger Yves comes to a similar conclusion. He wraps it into several conclusions:

Stocks: his bullish indicator has turned Yellow - time to take profits. It may shortly go into full sell mode. Neely has a similar view, that we may be in the final capitulation UP above S&P 1700 before a dramatic reversal.

Bonds: the effort to reflate the Japanese currency has caused damage to the confidence of Japanese bond investors due to a big pullback in bond prices. Ignore the bond vigilantes at your peril, Yves says! The vigilantes will work against the effort to reflate by dropping bond prices and negating monetary expansion. Instead, if this rolls into an even larger correction, it is deflationary.

Currency Wars: the drop in the Yen (30% so far) has a short term impact on Japanese profits due to increased sales (largely to China) but engenders a currency devaluation by trading partners. Already calls in Europe for a more expansion ECB approach. Profits in countries around Japan that also export to China - Korea, Hong Kong and Taiwan - are being hammered.

Deflation: The weakening of the Yen creates deflation in trading partners due to their relative currency strength, at least prior to a competitive devaluation.

US Dollar: In general it is thought to be going higher, in part due to the export of deflation by Japan combined with competitive devaluation by trading partners, and eventually Europe. Yves however thinks it is shortly to weaken, especially if the bond vigilantes thwart the super QE of Japan.