Japanese banks JGB exposure significant

Japanese banks JGB exposure significant

The Australian central bank, the RBA, is expected to cut interest rates by 25 bps tomorrow, down to 3.0%.

Australian October retail sales came in unchanged M/M, worse than the +0.4% expected and +0.5% in September;

Japanese financial institutions hold a massive amount of JGB’s, with the BIS reporting that Japanese banks hold 900% of their tier 1 capital in JGB’s. However, the Japanese authorities want to increase inflation – the likely next PM, Mr Abe (though his poll ratings are slipping – see below), suggests to 2.0%. He better be careful. If inflation rises, so do interest rates. Interest rates of 2.0% would equate to 100% of Japanese tax revenues, according to Barclays. In addition, it will also materially reduce the value of JGB’s owned by banks, which given the size of their holdings, is definitely scary. The FT reports that Japan’s biggest bank, Bank of Tokyo-Mitsubishi admits that it cant sell out of its US$485bn of holdings of JGB’s, without disrupting markets. The bottom line is that current yields (0.72% for the 10 year) are likely to rise. Banks will be wary of buying further JGB’s, given the size of their existing holdings, adding to the pressure on yields. Debt to GDP is around 220% and the budget deficit large – will Japan have problems financing its deficit?. Furthermore, Japan reported a seasonally adjusted current account deficit in September, the 1st since 1981. A resumption of electricity production from nuclear power stations will help, but is that possible, given voter opposition?

Today, Mr Abe reiterated his proposal that the BoJ undertakes unlimited buying of JGB’s and, in addition, to set an inflation target of 2.0%. The Yen recovered this morning on the poll news (see below) and traded near Yen 82 against the US$. However, I remain of the view that fundamentals suggest that the Yen should weaken, at least into the elections, unless, for example, the LDP lead declines materially;

Interesting recent polling in Japan. Support or the LDP has declined to 20%, from around 25% recently, whilst support for the DPJ has risen to 15%. Mr Abe’s comments are raising concerns. The Japanese Restoration party comes in third at 9%. No party will have a majority in the Upper House, which is necessary to pass legislation. Elections for seats in the Upper House are due in summer this year;

Some better news from Japan – capex in Q3, ex software, rose by +2,6% Y/Y, better than the +1.9% gain expected, The better number could improve the Q3 GDP estimate, though marginally. GDP is expected to decline this Q;

Chinese November PMI came in at 55.6, from 55.5 in October;

The HSBC’s India November manufacturing PMI came in at 53.7, better than the 52.9 in October and a 5 month high. The new orders and export components improved, a good sign.

The Indian government increased its caps on purchases of government and corporate bonds to US$15bn and US$25bn respectively, which should help the Rupee, even though its off today on profit taking;

Greece announced proposals to buy up to E10bn worth of its bonds, to be financed by 6 month EFSF paper. The buy back needs to be successful for the EZ/IMF to provide more funding for Greece, in accordance with the deal agreed last week – likely. The deadline for the bond buying plan is this Friday. Analysts expect 2/3rds of bondholders to tender their bonds. The buy back, to be conducted by means of a modified Dutch auction, will have a minimum range of 30.2% to 38.1% of par on some 20 outstanding bonds. The maximum range has been set at between 32.2% and 40.1%;

Italian November manufacturing PMI fell to 45.1, from 45.5 in October, below the 46.0 expected – the 16th monthly contraction. The new orders component declined to 42.2, from 44.4 in October.

Mr Bersani, head of Italy’s Democratic Party won the run-off against the more centrist Mr Renzi. Mr Bersani’s Democratic Party is expected to win next springs general elections and, if so, is unlikely to support retaining Mr Monti as PM. It looks as if the Italians re going to reject the current austerity policy. Mr Berlusconi continues to flap around, but Italian media suggests that his party has imploded and with little chance of being resurrected. However, the complicated new electoral law suggests that a coalition will be needed;

Irish November manufacturing PMI came in at 52.4, higher than the 52.1 in October;

EZ November final manufacturing PMI came in at 46.2, unchanged from the flash reading. However the output component came in better (46.1, from the flash number of 44.8), with the export orders component was also higher (46.4, up from the flash 45.9).

Spanish PM, Mr (ditherer) Rajoy has FINALLY admitted that it “may be difficult to meet the deficit target” of 6.3% this year. He also seems to be warming up the Spanish people to a request for a bail out . He stated “Up to this point I have not considered it (ECB bond buying) necessary, but if in future I think it is in our interests, I will not have any doubts about turning to the ECB”.

Some better news from Spain. November manufacturing PMI rose to 45.3, from 43.5 in October, the highest since July 2011. The output component rose to 46.3 from 42.5, the highest since June 2011. However, a number below 50 still signals contraction;

The German Bundestag’s vote to approve the continuing bail out of Greece will cost Germany. Mr Schaeuble admitted that the reduction in interest rates will reduce Germany’s 2013 revenues by E730mn. The vote was passed by 473 MP’s with 100 against and 11 abstentions, with the opposition SPD and the Greens voting in favour. Ultimately, Germany will have to take a hit on the loans provided to Greece, as they will never be repaid in full – however, that’s for after the German general election next September. Interestingly a German poll on Friday, suggested that a slim majority (46%) said that they would prefer Greece to go bankrupt, whilst 43% suggested that Greece should receive further support. However, 69% of those polled by ZDF, a German public television station, stated that Greece had not done enough, though. Is this the 1st sign that the EZ/Germany has signed up to the concept of a transfer union – may well be.

Mrs Merkel’s coalition understands that Germany will be forced to take losses on their bail out loans to Greece, as the level of outstanding debts remains unsustainable. Indeed, both Mrs Merkel and her finance minister, Mr Schaeuble are beginning to raise the possibility of debt forgiveness. Mrs Merkel, in an interview with a German newspaper (Bild am Sonntag) hinted as much, though stated that it will not happen before 2014/5 and only once Greece achieves a primary surplus. Previously, Germany has stated that debt forgiveness violated EU treaties !!!. Having said that, Mrs Merkel’s comments are particularly ill timed as Greece is starting its bond buy back programme today, with Greek bonds rising following her comments – when will these guys learn

Germany expects to have a balanced budget this year, with debt to GDP at 81.5% (200bps below forecast), falling to 73% in 2016. The MoF expect 2013 GDP to be “slightly positive”. Only the Germans – most countries will be green with envy
Moody’s unsurprisingly has downgraded the ESM and the EFSF by 1 notch to Aa1 and has maintained its negative outlook – no great surprise given the recent downgrade of France. They cite a high correlation in credit risk amongst EZ member countries and the recent downgrade of France, the 2nd largest contributor (20.4%) after Germany (27.1%). The Euro having traded above US$1.30 declined on the news. However, its back above US$1.30 at present, trading at US$1.3036, on Mrs Merkel’s comments and the Greek debt buy back;

The head of the Bank of France and ECB board member Mr Noyer wants Euro forex trading to be conducted within the EZ, rather than London. Typical French reaction. I thought that there was supposed to be no discrimination within the EU, Mr Noyer !!!;

UK November manufacturing PMI rose sharply to 49.1, well above the 48.0 expected and 47.5 in October. The new orders component rose to 49.7, from 47.7 in October. UK economic data is all over the place, but I continue to believe that the UK is doing better than expected. Sterling improved on the news;



Asian markets closed mixed, though China and Hong Kong closed over 1.0% lower. European markets are trading higher, with Spain and Italy over 1.0% higher. US futures suggest a higher open.

The Euro is rising – currently US$1.3042 – looks like it has a bit more to go.

Gold is trading around US$1715, with Brent at US$111.50.

The interesting issue is the continued weakness of Chinese markets. The better China PMI data seems focused on the the larger SOE’s, who clearly receive favourable treatment. Analysts talk about Chinese GDP at/over 8.0% – personally, I believe that’s grossly optimistic. Its impossible to assess the true number, but I would expect it would be materially lower.

Yet more concern over Japan. I will remain short the Yen, in spite of its modest recovery today – currently Yen 82.15, having been as low as Yen 82.02 this morning.

Mrs Merkels hints of debt forgiveness is material, given its a total reversal of previous German “policy”.

Ireland and Portugal are going to asking for equal treatment.

Still believe that US, UK and European markets offer reasonable opportunities – a number of investors are playing the EZ peripheral markets (Italy/Spain), as bond yields continue to decline.

Kiron Sarkar
December 3, 2012

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