The Year Of The Central Banks: The Godzilla Attack And The Refugee Camps

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Like a giant sumo wrestler pounding the ground with his feet on Japanese "bondland"... and maybe shouting FLEE!! RUN FOR YOUR LIVES! INVEST IN STOCKS! That was the mental picture I got from what happened last Friday. Maybe a Godzilla-induced panic could have been a more appropriate mental picture.

In the past, the fuzz was more about Mazinger, Samurais and Ninjas. Now the center of attention is more related to Kim Jong Un and massive QEs.

Japan has been aggressive with its monetary policy (or "ryoteki kinyu kanwa") since its asset bubble collapsed in the 90s. But fighting deflation in the rising sun island has not been easy. The inflation rate on February was -0.7% with an annual GDP growth of 0.5% for the 4th quarter, 2012. Unemployment however, hasn't been above 5% since 2010 and certainly not over 6% in the last 60 years or more. The planned purchases will expand the monetary base from 29% of GDP to 55% by the end of 2014. This round of quantitative easing will total about 1.4 trillion U.S. dollars in a period of two years. Yes, trillion with a T.

With an aging demographic profile, who knows if Japan will be able to reach its proposed 2% inflation target. But there is something we do know: this is an earthquake that is moving tectonic plates in the Pacific and has the potential of reshaping the landscape in other places.

The table below summarizes some of the action that happened last Friday, April 5, on bond markets around the globe.

Country 10-year bond yield change on April 5, 2013
Italy -3.91%
Spain -3.28%
Germany -2.18%
France -6.20%
U.S. -2.82%
Canada -2.18%
Brazil -3.10%
Japan +19.73%

These were some of the refugee camps for bond investors seeking higher yields. Japan's 10-Year increased almost 20% in one day. That's a fleeing stampede.

As money rushes out of the Japanese bond market, the more obvious and immediate implications are the devaluation of the yen and the further rise of Japanese stocks. But a large portion of that money will probably keep looking for higher bond yields somewhere else, as the "run for cover" action that unfolded last Friday suggests.

With these kind of movements in the bond markets, three quick things come to my limited mind:

  1. This could be a tailwind for the eurozone's recovery, specially for troubled countries like Italy and Spain, by lowering their borrowing costs for "free", as long as the euro dollar remains low enough to help their competitiveness.
  2. It may be more difficult now for the Fed to maintain its 2% inflation rate, which may lead to a longer than expected monetary easing (bullish for the market (NYSEARCA:SPY) on the long term).
  3. The yield curve may accelerate its decline because of refugees looking for asylum in longer term treasuries (NYSEARCA:TLT). This may in turn trigger a small short-term correction that may have been in the works for some time (bearish for the market on the short term).

The image below shows the yield-curve flattening action caused by the higher demand of longer-term Treasuries versus the shorter term bonds. The (NYSEARCA:IEF) to (TLT) ratio went on a "free fall" trip.

In tune with the money flow, emerging markets bonds (NYSEARCA:EMB), which provide higher yields, are going up in a hurry. Interesting times.

Let me know your thoughts on the new Japanese QE on the comments section. Until the next.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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