Disturbing Events in Japan, Part 2

February 10th, 2013
in contributors, forex

Lessons For This Week: Disturbing Developments From Japan, EU – Part 2

by Cliff Wachtel, Global Markets

Part 2 of 2

  • Conclusions, Lessons From Last Week  For This Week And Beyond
  • Weekly Currency Dilution Alerts
  • A New Way To Help Save Your Local Currency

In part 1 we broke down last week by each day to identify the top market movers for Asian, European, and US risk asset markets, and to help sort out implied conclusions and lessons for the coming week.

Here are the big conclusions and lessons for this week and beyond.

Follow up:


The Positive: Signs Of Health From China, US Trade Figures Friday

China’s January trade figures exceeded forecasts, suggesting continued improvement in the second largest economy and the world’s top growth engine.  Imports surged 28.8%, versus an expected 23.5 %.  Exports were up 25% versus and expected 17.5%.  In sum, both China and its customers are spending more and showing greater health than expected. The only qualification to the data was that it was probably somewhat distorted to the upside due there being an extra 5 working days in January 2013 than there were in January 2012.

The U.S. trade deficit plunged 20.7% to $38.5 bln versus an expected  $46.0 billion.  The shrinkage was due in large part to a drop in energy imports and a large rise in energy exports.  Per, Bloomberg, this was the lowest petroleum deficit since August 2009.  Year over year, barrels of crude oil imported fell to its lowest level since 1997.

Disturbing Development #1: Japan’s Deteriorating Trade Data

Japan’s deteriorating trade data is yet another sign of what appears to be an eventual (timing unknown) but thus far unavoidable crash of the world’s third largest economy.

  • Japan is an export economy, and so if healthy should post solid current account data.
  • There are two reasons Japan’s government has among the lowest borrowing costs in the world.
    • Japan’ traditionally strong current account and trade balance is one of the reasons its sovereign bonds are bought despite their extremely low yields, despite its having the highest debt/GDP ratio in the developed world. Japan is like a high income individual with high debt, it’s considered credit worthy based on its income.
    • The other reason Japan bonds sold at high prices and low yields was strong domestic demand, but that’s fading too because its rapidly aging population (25% over age 65) is buying fewer bonds as more hit retirement age.

As these twin pillars supporting low Japanese borrowing costs crumble, Japan seems an economic disaster waiting to happen.

Japan cannot stay solvent for long if it’s benchmark 10 bond rate rises from its current ~1% to even just 2% (similar to that of the US). Even at current low rates, its debt service expense consumes well over 25% of its national budget. I’m only talking about its federal debt. Leave regional and municipal debt for another time.

Just a 1% increase in its benchmark yields could double its debt service costs, which would become the majority of its budget. This will not end well. The only question is when. I’m hardly the first to point this out, but shorting Japan thus far based on its shaky fundamentals has been a loser’s game.  Those who have tried shorting Japanese government bonds in the past have lost badly, and the trade is thus known as “the widow maker’s” trade.

Sure, Japan can always repay the bonds, because they can print all the yen the want. The question is what those yen will be worth. As long as bond buyers believe they’ll be repaid in yen of equal or higher value, they may well continue to buy Japan bonds at these low rates.

So the real question on which Japan’s fate depends, is how it plans on maintaining confidence in the value of the JPY, when they are aggressively trying to drive it lower?

Ultimately they can’t have it both ways forever.

  • They can have a much weaker Yen and boost exports, and their stocks.
  • They can maintain confidence in the Yen and keep bond rates low, as long as their trade data remains sound.

Disturbing Development #2: Spain, Italy Threaten Fragile Confidence Risk Asset Rally

Here’s the bigger near term threat.

The current rally in risk assets is, more than anything else, based on improved confidence concerning the biggest market moving issue since 2010, the EU sovereign debt and banking crisis.

That’s all it’s based on, confidence that all will be ok. Outside of Germany and a few other small funding nations, actual economic data and earnings in the EU have deteriorated.

Political events of the past week in Spain and Italy are the latest real threat to that confidence on which the rally that began this past summer.

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