On Thursday afternoon, following a well-bid treasury bond auction, the Japanese yen suddenly cratered. The move continued in Asian trading overnight, and caused a number of interrelated markets to make big moves as well. Below are the yen's short term (June futures contract) and daily charts illustrating the situation. Note that the charts are in the inverse type of notation that shows how many US cents are required to buy 100 yen - usually dollar/yen is shown the other way around. We prefer this notation because "down" means "the yen is weakening" on this chart. This is just to avoid confusion, as in the usual notation, the yen went "above 100," while it went "below 100" when looked at in the manner depicted below.
The yen gets pasted once again - June futures contract, 30 minute candles.
Yen, daily chart - new lows for the move are made with gusto.
When trading in JGBs began in Asia overnight, it soon became clear that this move in the currency would not be shrugged off by the bond market this time. Trading in JGBs was even halted for a brief time as volatility spiked. As Reuters reports, "JGB yields had their biggest rise since May 2008:"
"Japanese government bonds plunged on Friday, with the benchmark yield marking its biggest one-day rise in five years, as accelerating yen weakness sent Japanese stocks soaring.
The 10-year Japanese government bond yield surged 10 basis points to 0.690 percent, after rising as high as 0.700 percent earlier for the first time since Feb. 25.
"The dollar/yen rose above 100, the Nikkei continued to go higher, and this led to a massive liquidation in the JGB market, where especially futures and the 10-year sector got hit hard," said Tadashi Matsukawa, head of fixed-income at Pinebridge Investments in Tokyo. "We are starting to think that this is not really something normal, and I think we started to realize we need to be very defensive at this moment," he added. If the dollar were to rise to 105 yen, the 10-year could rise to 0.8 or 0.9 percent, he estimated.
Japanese banks and speculative accounts were said to be heavy sellers, market participants said, and yanked the benchmark yield above its recent trading range of 0.55 to 0.65 percent to which it had held since last late month.
The important aspect of this is of course that the "recent trading range" has been broken. This means that the way is now open for an even bigger rise in yields. The Japanese bond market's curious equanimity in the face of the BoJ's crazy activism may finally be ending.
JGB prices begin to decline with some verve (each candle represents four hours).
JGB, 30 minute candlesticks.
Needless to say, these developments in the JGB market are rather ominous. It is actually too early to tell if the breakdown is going to be sustained and lead to a downtrend on a much larger scale, but the chances of that happening have increased greatly now.
Front-Running the Behemoths
The one market that continues to be happy with Kuroda-san's policy of currency debasement is the Japanese stock market. Its stunning ascent continued overnight, with the Nikkei ending at a new 5 year high. It is astonishing to see a developed economy stock market rise by over 50% in the space of a few months. This really doesn't happen very often - the last time something similar happened in Japan was back when it was still considered an "emerging market" in the mid 1950s. The year after the 50% rise in the Nikkei in such a short time took place in the 1950s, CPI inflation soared to over 10%. This is not meant to suggest that the same is going to happen this time around. In fact, we continue to believe that it is just as likely for the inflationary policy of Kuroda to fail as it is for it to "succeed." Success - and we definitely agree on this point with Edward Hugh, whose recent article on Japan we referred to in our last Japan-related missive on Tuesday - will likely require continual debasement i.e., Kuroda will have to essentially crash the yen.
We would submit that at some point the stock market will no longer be happy with this policy of currency debasement. That point will arrive if and when the market concludes that the BoJ no longer has things under control. The market most likely to signal a loss of control is the JGB market.
As Mrs. Christine Hughes of Otterwood Capital shows in this presentation on the BoJ's new policy, the largest institutional holders of JGBs are among the slowest movers in the realm of institutional investors (pension funds, the post office, insurers…). Their investment committees very likely have yet to decide what moves to implement next. So what we are currently seeing in the markets is the entire herd of more fleet-footed investors such as hedge funds, CTAs and so forth attempting to front-run these big fish.
The Nikkei's relentless rise continues - so far.
Lastly, there are a great many inter-market implications tied to the recent move in the yen in particular. One of the markets most strongly hit by the yen's demise was evidently the gold market. With regard to gold we are beginning to feel like the patron saint of lost causes. Gold is discussed in the next article.
So far, market participants are seemingly still clinging to their faith that Mr. Kuroda will succeed in magically restoring Japan to prosperity by means of the printing press and remain in control of the processes he has set in motion, in spite of the recently growing volatility in JGBs and the yen.
However, the current phase of "prosperity" as evidenced by the relentless rise in Japanese stock prices is no different from the sham prosperity the revolutionary assembly of France created for a little while when it printed its first issue of assignats. Inflation always seems to provide a "shot in the arm" to the economy in the short term.
The problem is that as soon as the policy is discontinued, things go back to an even worse state than before. This then means that the inflationary policy can never be stopped - but that invariably leads to the demise of the entire underlying currency system. Neither Mr. Kuroda nor any other central banker can suspend the laws of economics. The policy Japan has embarked on threatens to eventually lead to a conflagration that will make the crises we have seen in recent decades look like a walk in the park.