38029534-SG-Japan-US

8/8/2019 38029534-SG-Japan-US

1/16

Macro Commodities Forex Rates Equity Credit Derivatives

23 S eptemb er 2 010

Cross AssetsSpecial report

www.sgresearch.com

Japan parallelsNot just a case of history repeating itself

Unc er tainti e s ab ound re garding e c on omi c gro wth and r e c over y prosp e c ts in d e vel ope d

c ountrie s. Bu t the currenc y trend in the s e countri e s has nothing in c ommon wi th Jap an in the

19 90s and c or p or a te situati ons are sound, wi th limite d d ebt. While we i d enti fy some similariti e s

b e twe en Jap ans lo s t d e cade s and th e cur rent si tu a tion in th e US and in Europ e, we c arr y out a

region-by-re gion inve sti gati on and c onclude th a t the situ ati on is ver y dif ferent.

Q Ja p ans los t de cad es

- Japans lost decades have been associated with having the strongest currency in theworld.

- Nominal 10-year JGB yields peaked in September 1990 at over 8% and have sincedeclined steadily.

Q Pr ompt p olic y re spons e in the US

- The US policy response compared with Japan was both faster and more aggressive.- The US enjoys good demographics: Japans working age population is shrinking, while

the same segment of the US population is still growing.- In the US, 10-year swap rates have declined some 520bp from their recent peak in 2000.

Q No e xc e s s lev era ge in the euro ar ea

- No excess leverage in aggregate on non-financial corporate or household balancesheets: Local excesses such as in Ireland and Spain, but not on an aggregated level.

- Significant intra-euro area divergence: The euro area has substantial divergence betweenmember states both on public finances and economic growth prospects.

Q Rapid fi s c al repair in the UK

- Excess leverage in the UK not located on corporate balance sheets, but on householdbalance sheets.

- The UK is committed to rapid fiscal repair and is planning the tightest of the G4 fiscal

policies.

Pr oje ct m ana ger Daniel F erm on Mi chal a Marcu s s en Vinc ent Ch ai gn ea u(33) 1 42 13 xx xx (33) 1 42 13 00 34 (44) 20 7676 [email protected] [email protected] [email protected]

Alain B okobz a Cl au di a P an s eri Ki t Jucke s(33) 1 42 13 84 38 (33) 1 58 98 53 35 (44) 20 7676 7972

[email protected] [email protected] [email protected]

Notice to US investors: Written by a non-US research analyst not registered/qualified under FINRA RulesTHIS RESEARCH REPORT IS THE PRODUCT OF SOCIETE GENERALE (AUTHORIZED IN FRANCE BY THE AMF)

PLEASE SEE IMPORTANT DISCLOSURES AND ANALYST CERTIFICATION IN THE APPENDIX

FUZ

8/8/2019 38029534-SG-Japan-US

2/16

Japan parallels

23 S ept emb er 2 0102

Contents

3 Key conclusions

3 Why some investors believe we are experiencing a Japanese-style lost decade

4 Western economies in much better shape than Japan during the lost decades

5 Japan during the lost decades

7 Comparison with the 2010 US situation

9 What differentiates the US now from Japan then?

10 Comparison with 2010 eurozone situation

12 What differentiates Europe now from Japan then?

13 Comparison with the 2010 UK situation

15 What differentiates the UK now from Japan then?

Thanks to Nicolas Harari for his assistance in preparing this report.

FUZ

8/8/2019 38029534-SG-Japan-US

3/16

Japan parallels

23 S ept emb er 2 010 3

Key conclusions

Why some investors believe we are experiencing a Japanese-st yle lost decadeIs history just repeating itself? Although history never repeats itself in exactly the same way,there are a number of striking similarities between the economic situation the world iswitnessing today and the situation that arose in Japan in the 1990s and indeed in the firstdecade of the new millennium (Japans so-called lost decades). Why this period of economichistory can help us understand and forecast outcomes from todays situation can be summedup in three words: balance sheet recession .

Today, both the US and Europe are facing the same challenges: fallout from the bursting ofthe asset-price bubble, which has led to dramatic declines in equity and real estate pricesversus their peaks. Parallels have been drawn between the current situation and financialsector behaviour in Japan in the 1980s (when the asset-price bubble burst) and the USsituation at the height of the subprime lending spree in 2008 (see 19 December 2008 reportfrom SG Economists and SG Quantitative strategists A historical perspective on the crisis ).

Another similarity lies in bond markets which reached new lows in Europe in August and areclose to bottom in the US. Finally, equity market trends look pretty much the same as they didin Japan during the lost decades, and this could also fuel investor concerns.

US e quit y mar ket wi th 10-ye ar lag c ompare d to Japan U S b on d market with 10-y e ar lag c omp are d to Jap an

0

1

2

3

4

5

6

7

0

1 0 0 0

2 0 0 0

3 0 0 0

4 0 0 0

5 0 0 0

6 0 0 0

7 0 0 0

8 0 0 0

Duration (Days)

Nikkei 225 (starting in 1980) S&P 500 (s tarti ng i n 1990)

Japanese RealEstate andValuation Crisis

USValuation

Crisis

0

1

2

3

4

5

67

8

9

0 5 0 0

1 0 0 0

1 5 0 0

2 0 0 0

2 5 0 0

3 0 0 0

3 5 0 0

4 0 0 0

4 5 0 0

5 0 0 0

Duration (days)

Japan 10-year bond yield (starting in 1990)US 10-year bond yield (star ting in 2000)German 10-year bond yield ( starting in 2000)

Bond yield on a cont inuingdownward trend ...

Source: SG Cross Asset Research

However, below we identify two significant factors that illustrate that the root causes ofJapans lost decades are not present in todays situation:

Japans keiretsu corporate organisation, with companies grouped together intoconglomerate-like structures, each including a large bank and several corporations, producedan excessive amount of bad loans.

Japanese businesses used to be extremely dependent on debt financing, with Japanesefirms five times as leveraged as US corporations in the 1980s. As asset prices wereappreciating steadily, there was no concern about debt repayment. This also involvedwidespread use of land at inflated prices as collateral.

These two factors must not be overlooked when comparing the current situation with Japanslost decades. Importantly, these two balance sheet recessions reveal that things were verydifferent then compared with now when we consider the prevailing economic environment.

FUZ

8/8/2019 38029534-SG-Japan-US

4/16

Japan parallels


Wes ter n economies in much better shape than Japan dur ingthe lost decadesLets assume that equity markets and house prices have not yet hit bottom and that a further15-20% decline is still possible.

While the key debate could well continue to focus on whether the US and European countriesare in a similar situation to that experienced by Japan, we note significant structuraldifferences:

First, speed of government action : in the US and in Europe, governments acted swiftly toaddress the banking crisis, almost immediately recognising and writing off non-performingloans, in stark contrast to the hesitant approach adopted in Japan. Resolution of the crisis inthe US was facilitated by the rapidity of capital injections, first by the sovereign wealth sector,and then by the US Treasury.

Second, currency adjustments . Yen appreciation in the 1990s had a considerable negativeimpact on the Japanese economy; conversely, more recently, western countries sufferedcurrency depreciation versus emerging market currencies and even more recently against theyen.

Third, the balance of payments situation is very different . Even during its lost decades,Japan managed to post a current account surplus, whereas the US and most Europeancountries have current account deficits at present.

Finally, population trends . Demographics in Japan were quiet different compared with thecurrent situation in the US and Europe. In Europe, only Germany and, to a lesser extent, Italy,could be compared to the demographic situation in Japan during its lost decades. But evenso, property bubbles have not developed in ei ther Germany or Italy. Its also important to note

that the recent US property bubble was significantly smaller than in Japan in the 1990s.

Populati on tren d with 10-y e ar lag c omp are d to Jap an Proper ty tren d wi th 15-y ear la g compar e d to J ap a n

1995 2000 2005 2010 2015 2020

100

102

104

106

108

110

112

114

116

118

100

102

104

106

108

110

112

114

116

118

1985 1990 1995 2000 2005 2010

Japan population trendUS population trendUK population trendFrance population trend

1996 2001 2006 2011 2016 2021 2026

50

100

150

200

250

300

350

400

50

100

150

200

250

300

350

400

1980 1985 1990 1995 2000 2005 2010Japan residenti al p roper ty pr ice UK residenti al proper ty pr iceFrance residential property price US residential property price


In conclusion, while we identify some similarities with Japans lost decades and the currentsituation in the US and in Europe, in this report, we carry out a region-by-region investigationand conclude that the situation is very different. Uncertainties abound regarding economicgrowth and recovery prospects in developed countries, but corporate situations are soundwith limited debt, and world economic growth appears to be fairly solid.

FUZ

8/8/2019 38029534-SG-Japan-US

5/16

Japan parallels

23 S ept emb er 2 010 5

Japan during the lost decades

-2.00-1.000.001.002.003.004.005.006.007.008.00

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Oct 87 Jan 91 Apr 94 Jul 97 Oct 00 Jan 04 Apr 07 Jul 10

Nikkei 10-year JGB Japan CPI Inflation

Movement of rates: Nominal 10-year JGB yieldspeaked in Sept. 1990 at over 8% and have since beenin a long-term decline, touching a record low ofunder 0.5% by May 2003.

Since this low, the 10-year yields have averaged about1.5%, underpinned by strong deflationary pressuresand in spite of rising budget deficits.

The decline in yields and inflation was triggered by theend of the equity and land price bubble. Equitiespeaked in December 1989 and land prices in Q3 1990.

-100

-50

0

50

100

150

200

250

300

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0


10-year JGB 2y-10y JGB 5y-20y

Shape of curve: As 10-year yields declined, the JGBcurve steepened steadily until Q3 1992. Since thenthe curve has stabilised at around 130bp for 2y-10yJGBs and 58bp for 10y-20y JGBs (a 30-year JGBissue was first introduced in Sept. 1999).

The key characteristic of the JGB curve is that itbecame very directional: steepening in a sell-off andflattening in a rally. This reflected policy rates alwaysbeing kept very close to zero and the yield curve

pricing in a normalisation of BoJ policy rates that hasyet to materialise.

-30

-20

-100

10

20

30

40

50

60

70

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0


10-year JGB 10y ASW

Swap spreads: JGB swap spreads only startedtrading in the late 1980s and were very volatile.Through the end of the 1990s they averaged about+30bp (IRS JGB yield) but since 2000 they started acheapening process to average about +10bp since2000.

This coincided, as theory suggests, with the

deterioration in Japans fiscal balances (+1.9% ofGDP average in the 1990s and -4.0% since 2000).

As was the case with the JGB curve, ASW*directionality also switched from negative until themid-90s to positive, where it has been ever since. *ASW = asset swap

Source: SG Cross Asset Research, Datastream

FUZ

8/8/2019 38029534-SG-Japan-US

6/16

Japan parallels


0

20

40

60

80

100

120

140

-

0.5

1.0

1.5

2.0

2.5

3.03.5

4.0

Oct 95 Jan 99 Apr 02 Jul 05 Oct 08

10-ye ar J GB 3mx10y Normal swaption Vol

Behaviour of volatility: Interest rate volatility(swaptions) started trading only in the mid-1990s,many years after the start of the 10-year JGB yielddecline. The product reflected onshore demand foryield-enhancement products.

Gamma normalised volatilities have been directionaland mean reverting. Vega volatilities have more orless followed the same pattern but, on manyoccasions, the payer skew has become hyper-lognormal primarily reflecting (offshore investor)views of a potential fiscal collapse. Such trades have,on every occasion, failed.

Currency behaviour: Japans lost decades havebeen associated with the country having thestrongest currency in the world. The yen has beenboth a large part of the reason for the difficultyexperienced in escaping deflation, and a reflection offalling relative prices since 1990, US consumerprices have risen by 71%, Japans by just 7%.

What this highlights for the US is the need to maintaina competitive currency. The 25% dollar appreciation(on a trade-weighted basis) between the summer of2008 and February 2009 will be seen as a source of

concern, not pride.

0

500

1000

1500

2000

2500

3000

3500

Jun-89 Dec-91 Jun-94 Dec-96 Jun-99 Dec-01 Jun-04 Dec-06 Jun-09

Topix

Equity: As is well known, the Japanese marketpeaked in December 1989 at a price-to-earnings ratioin excess of 50x, well above the markets current P/E.

The market has since been on a downtrend that has,however, been interrupted by powerful and investablerallies.

These rallies were coincident with upturns in theglobal economic cycle.

Source: SG Cross Asset Research, Datastream

FUZ

8/8/2019 38029534-SG-Japan-US

7/16

Japan parallels

23 S ept emb er 2 010 7

Comparison with the 2010 US situation

Mo vements of rate s in Japan M ovement s of r a te s in the US

0

2

4

6

8

1989 1994 1999 2004 2009

J P Y 1 0 y s w a p

[ % ]

650bp

0

2

4

6

8

10

1989 1994 1999 2004 2009

U S D 1 0 y s w a p

[ % ]

520bp

130bp


Sh ap e of th e cur ve in Japan Sh ap e of th e cur ve in th e US

-100

0

100

200

1989 1994 1999 2004 2009 J P Y 2 s 1 0 s s w a p

[ b p

]345bp

0

100

200

300

1989 1994 1999 2004 2009

U S D 2 s 1 0 s s w p

[ b p

]

300bp


Swap spre ads in Jap a n S wap spr e a d s in the US

-25

0

25

50

75

1989 1994 1999 2004 2009

J P Y 1 0 y s p r e a d

b p

]


From their peak in 1990, 10-year swap rates in Japan droppedsome 650bp until stabilisingaround 1.50% from 1999. In theUS, 10-year swap rates havedropped some 520bp so far fromtheir recent peak in 2000.

Assuming that US rates will levelout after a decline similar to thatin Japan, one would expect anadditional 130bp decrease inrates.

Japans curve steepened from aninverted -90bp in 2s10s swaps in1990 to 255bp in 1995, a 345bpmove. In the US, the 2s10s slopehas been extremely volatile since2000, first pushing up fromaround zero to 300bp, then back to zero and up to 265bp.

Most recently, the curve has beenflattening again. Some of the

excess volatility in the US is dueto non-inversion note hedging.

It is not clear whether the JPY swap spread is a goodcomparison for USD swapspreads. In the US, the swapspread tends to be more volatiledue to mortgage convexityhedging.

However, one observation is thatalthough JPY 10y swap spreadspushed below zero, they never went below -25bp. In the US, wehave just experienced negative10y spreads and may expect afloor around -25bp as well.

FUZ

8/8/2019 38029534-SG-Japan-US

8/16

Japan parallels


Beha viour of v ola tility in Japan B ehaviour of volatili ty in the US

012345678

9

99 00 01 02 03 04 05 06 07 08

JPY vol 3M10Y JPY vol 3M2Y

ZIRP Quantitative Easing

bp/day

0

5

10

15

20

Jan-07 Jan-08 Jan-09 Jan-10

USD vol 3M10Y USD vol 3M2Y

bp/day

Lehman Quantitative Easing


Currenc y b ehaviour in Jap an Cur rency b ehavi our in the US

75

85

95

105

115

125

135

145

155

1989 1992 1995 1998 2001 2004 2007

Japanese Yen to USD

Yenappreciation

Yenappreciation


Equi tie s in Japan E qui tie s in th e U S

0

500

1000

1500

2000

2500

3000

3500

Jun- 89 Dec-91 Jun-94 Dec-96 Jun-99 Dec-01 Jun-04 Dec- 06 Jun-09

Topix

600

700

800

900

1000

1100

1200

1300

1400

1500

1600

Mar-07 Jan-08 Nov-08 Sep-09 Jul-10

S&P 500


The JPY 3m2y vol dropped to ahistorical low after theintroduction of ZIRP and thencollapsed to as low as 0.3bp/dayduring the first two years of QE.The 3m10y vol was followingshort rates vol lower until the H22003 sell-off.

In US, we are observing quite asimilar pattern. The 3m2y vol hasdropped to historical lows and istending to exert a negative effecton longer-tail vol. In absolutevalues, USD rates vol remainshigher than JPY rates vol.

The good news for the US, withits huge trade deficit, is thatundermining the dollar is far easier to achieve than weakeningthe yen appears to have been. USdevaluation/debasement policiesremain intact.

The fear, then, must be that inrunning policies designed to avoidbeing like Japan, at all costs, theUS will end up with somethingvery different indeed successfully undermining thedollar and ultimately causing areturn of inflation.

Equities in the US peaked inOctober 2007. They rallied sharplyfrom March 2009 to April 2010.

They have been trending lower since. This pattern is similar to theJapanese price action betweenthe second half of 1992 and thefirst half of 1993. Financials

initially led the market higher inboth cases.

Reassuringly, the US equitymarket was not as expensive asthe Japanese one at the peak.

FUZ

8/8/2019 38029534-SG-Japan-US

9/16

Japan parallels

23 S ept emb er 2 010 9

What dif ferentiates the US now from Japan then?

Similarities

Excess leverage The private sector took on excess leverage

in the pre-crisis period fuelled by over optimism, financial

deregulation and a lax attitude to credit.

and asset prices bubbles Asset price bubbles resulted

from the situation above; eventually those bubbles burst.

Bank failures The crisis resulted in the failure of systemically

important financial institutions.

Explosion of public deficits Public deficits have widened

substantially, due to the crisis but are also burdened by

structural issues.

Reform: The crisis triggered deep-rooted reform of the financialsector.

Differences

Excess leverage, but not on corporate balance sheets US

excess leverage is on the balance sheets of households and small

businesses.

Prompt policy response The US policy response was both

faster and more aggressive than that of Japan.

The US enjoys good demographics Japans working-age

population is shrinking, whilst the USs is still growing.

The US is a deficit economy with no structural demand

problem The US depends heavily on foreign investors, unlike

Japan.

The US dollar is the worlds reserve currency This offers an

advantage as many players worldwide have a vested interest in the

greenback.

The US end-g a me - E xtern a l rebalancin g

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

85 87 89 91 93 95 97 99 01 03 05 07 09

% of GDP

US Japan


SG view Like Japan in the lost decades, the US is today suffering de-leveraging pressures.However, we cannot conclude that the US is facing a structural demand problem. On thecontrary, the external deficit suggests a shortage of savings, which, from a structuralstandpoint, should be pressuring the dollar lower and bond yields higher.

FUZ

8/8/2019 38029534-SG-Japan-US

10/16

Japan parallels

23 S ept emb er 2 01010

Comparison with 2010 eurozone situation

Mo vements of rate s in Japan M ovement s of r a te s in Europ e

0

2

4

6

8

1989 1994 1999 2004 2009

J P Y 1 0 y s w a p

[ % ]

650bp

0

1

2

3

4

5

6

7

8

9

10

Sep 89 Sep 92 Sep 95 Sep 98 Sep 01 Sep 04 Sep 07 Sep 10

10-ye ar JGB 10y Bund


Sh ap e of cur ve s in Japan Shap e of cur ve s in Eur op e


Swap spre ads in Jap a n Swap spre a ds in Europ e

-25

0

25

50

75

1989 1994 1999 2004 2009

J P Y 1 0 y s p r e a d

b p

]


JPY long-term rates eventuallystabilised at 1.50%, excluding thebubble period of H1 2003. EURIRS do not go back as far back asthe late 1980s but 10-year Bundsat 2.11% by end Aug-2010suggest that the yield downside incore EUR rates may be lot morelimited than in USD: 50-60bp ifBEI indeed contract to Japan-style levels.

As in the US, the EUR curve hasbecome very directional, i.e.driven by the long end. The curveflattens as rates fall, and steepensas rate rises.

In a bullish environment the curvewould flatten aggressively again,as there is limited scope for 2yyields to move to the downside. Ina low-yield environment, thecurve segmentation implies that10-30y lags 2-10y on theflattening move. Expect the 2-10-30y barbell in EUR to fall further ina Japan-style bond rally.

The German fiscal situation is far better than that in Japan. It alsoappears healthier than that ofmost its EU partners, so Germanbonds tend to benefit from flight-

to-quality flows in a crisisenvironment. This would mostlikely be the case in a low-growth/low-inflation environmentthat would make the fiscalconsolidation of non-core EMUever harder to achieve. SoGerman swap spreads may notreverse as they occasionally didin Japan. Our swap spread modelpredicts low but positive EURswap spreads over the comingyear

FUZ

8/8/2019 38029534-SG-Japan-US

11/16

Japan parallels

23 S ept emb er 2 010 11

Beha viour of v olatilit y in Japan B ehaviour of volatili ty in Eur op e

0123456789

99 00 01 02 03 04 05 06 07 08

JPY vol 3M10Y JPY vol 3M2Y

ZIRP Quantitative Easing

bp/day

0123456789

10

11

99 00 01 02 03 04 05 06 07 08 09 10

EUR vol 3m2y EUR vol 3m10y

bp/day


Currency b ehaviour in Jap an Cur rency b eh avi our in Europe

85

100

115

130

145

160

175

1999 2001 2003 2005 2007 2009

Japanese Yen to

Yenappreciation


Equi tie s in Japan E qui tie s in Europ e

0

500

1000

1500

2000

2500

3000

3500

Jun- 89 Dec-91 Jun-94 Dec-96 Jun-99 Dec-01 Jun-04 Dec- 06 Jun-09

Topix

150

200

250

300

350

400

450

Apr-07 Feb-08 Dec-08 Oct-09 Aug-10

STOXX 600


Long-tails of EUR impliedvolatilities traded at similar levelsto JPY (excluding the JGBbubble), especially during 2004-07when structured products weremost popular. If deflationaryexpectations materialised in theeurozone and the ECB respondedwith QE-type measures, mostdownside on EUR volatility wouldbe on short-tails. The volatilitysurface would likely becomesteeper too.

Deflation is not the direct driver ofthe trend in the euro. Arguably,Europe is more at risk of Japan-style deflation than the US is.However, the last year has shownthat deflation presents a verydifferent threat for Europe as itcould dramatically exacerbate thedeterioration in peripheral nations'fiscal position. The driver of thetrend in the euro will therefore behow fear of default evolves.

The European equity marketpeaked in July 2007. Like the USmarket, it bounced between earlyMarch 2009 and April 2010, againmirroring the 1992-93 Japaneseprice action. As in Japan, thesegyrations have been driven bycyclical indicators.

FUZ

8/8/2019 38029534-SG-Japan-US

12/16

Japan parallels

23 S ept emb er 2 01012

What dif fer entiates Europe now f r om Japan then?

Similarities

Excess leverage on financial sector balance sheets The

financial sector took on excess leverage in the pre-crisis period

fuelled by over optimism, financial deregulation and a lax

attitude to credit.

Bank failures The crisis resulted in major tensions.

A structural demand problem Structurally deficient labour

markets and fiscal tightening plead for weak income growth.


substantially due to the crisis, but are also burdened by

structural issues.

Reform The crisis has triggered deep-rooted reform of thefinancial sector.

Differences No excess leverage in aggregate on non-financial corporate

or household balance sheets Localised excess in Ireland,

Spain, etc., but not on an aggregate level.

Real-estate bubbles only localised: even though many euro

area countries saw firm real estate gains in the pre-crisis era

Large intra-euro area divergence The euro area member

states show a marked divergence in both public finances and

economic growth prospects.

No single fiscal policy The euro area does no enjoy the

benefits of a single central strong fiscal authority.

A ver y dif ferent pi cture on b alanc e- sh eet levera geEuro area Household debt to GDP ratio (% GDP) Euro area Non-Financia l corporations debt to GDP (%)

0

20

40

60

80

100

120

140

A u s t r i a

B e l g i u m

C y p r u s

G e r m a n y

S p a i n

F i n l a n d

F r a n c e

G r e e c e

I r e l a n d

I t a l y

L u x e m b o u r g

M a l t a

N e t h e r l a n d s

P o r t u g u a l

S l o v e n i a

S l o v a k i a

22000033

22000099

0

20

40

60

80

100

120

140

160

180

200

A u s t r i a

B e l g i u m

C y p r u s

G e r m a n y

S p a i n

F i n l a n d

F r a n c e

G r e e c e

I r e l a n d

I t a l y

L u x e m b o u r g

M a l t a

N e t h e r l a n d s

P o r t u g u a l

S l o v e n i a

S l o v a k i a

22000033

22000099


SG view

While we find that both the household and corporate sectors in the euro area havesignificantly increased their net saving, the balance sheets for both sectors do not indicatethere has been a huge destruction in wealth on a Japanese scale. This suggests that thereis little risk of a balance-sheet recession in the euro area. Instead, we are concerned thatthe euro area will suffer a structural inability to generate sufficient aggregate demand to

make use of the economys available resources.

FUZ

8/8/2019 38029534-SG-Japan-US

13/16

Japan parallels

23 S ept emb er 2 010 13

Comparison with the 2010 UK situationMov ements of rate s in Japan Mov ements of r ate s in the UK

-3-2-10123

01/08 07/08 01/09 07/09 01/10 07/10

10y JPY10y JPY Inflation

%

02468

101214

89 94 99 04 09

10Y GBP Swa p rate


Sh ap e of cur ve s in Japan Shap e of cur ve s in th e UK

0

1

2

3

4

03 04 05 06 07 08 09 10

10y JPY 10y20y JPY

%

2

3

4

5

6

03 04 05 06 07 08 09 10

10y GBP 10y20y GBP

%


Swap spre ads in Jap a n Swap spre a ds in th e UK

-20

0

20

40

60

80

98 00 02 04 06 08 10

JPY 10Y s pread, bp

-10

-8

-6

-4-2

0

2

4

6

-50

-25

0

25

50

75

100

125

150

175

88 90 92 94 96 98 00 02 04 06 08 10

10-year ASW, LHS, bpBudget Deficit/GDP, %, RHS inverted


The UK, like Japan, has now

pursued full-blown governmentbond-buying quantitative easingto an extent not yet tried in the USor the euro area (where centralbank action was closer to crediteasing). The UK yieldcomposition contrasts sharplywith Japan. In the UK, 10ynominal and inflation swap ratesare both c.3.25%, so the real yieldis zero. In Japan, a negative 10yinflation swap rate leaves the realrate still significantly positive.

In the UK, one characteristicfeature of the crisis has been thereluctance of long-dated forwardyields to fall. Perhaps like Japan this reflects distant credit and/or inflation fears, that quantitativeeasing might even encourage.From a receiving standpoint, weregard forward yields that are nowback above pre-crisis levels asattractive.

10-year gilt swap spreads, now at7bp, traded below zero for mostof H1 2010. This is not surprising,given the relationship with thedeficit (charted). However, weexpect spreads to remain inpositive territory given: i) the carryearned on long ASW positions; ii)the ongoing demand from banksto hold risk-free assets for liquidity purposes; and iii)expected future improvements inpublic finances.

FUZ

8/8/2019 38029534-SG-Japan-US

14/16

Japan parallels

23 S ept emb er 2 01014

Beha viour of v olatilit y in Japan B ehaviour of volatili ty in the UK

0

20

40

60

80

100

00 01 02 03 04 05 06 07 08 09 10

1y->2y JPY NormVol1y->10y JPY NormVol

bp

50

70

90

110

130150

00 01 02 03 04 05 06 07 08 09 10

1y->2y GBP NormVol1y->10y GBP NormVol

bp


Currency b ehaviour in Jap an Cur rency b eh avi our in the UK

100

120

140

160

180

200

220

240

260

280

300

1989 1992 1995 1998 2001 2004 2007

Japanese Yen to

Yenappreciation

Yenappreciation


Equi tie s in Japan E quiti e s in the UK

0

500

1000

1500

2000

2500

3000

3500

Jun-89 Dec- 91 Jun-94 Dec- 96 Jun- 99 Dec-01 Jun- 04 Dec-06 Jun-09

Topix

1500

2000

2500

3000

3500

4000

Jun-06 Apr-07 Feb-08 Dec-08 Oct-09 Aug-10

FTSE All Share


The Japanisation of markets,characterised by bull flattening

and bear steepening, is reflectedin the term structure of volatility inthe US and euro area. The UK stands alone in resisting 1y->10ynormalised volatility pushingbelow 1y->2y.

If there is a major economy wheredeflation appears a limited risk, itis the UK. Inflation is proving verysticky and that, in turn, isanchoring inflation expectations.This brings its own problems for policy-makers, but there is nosimilarity between the Japanesedeflation experience and what theUK's MPC faces.

The UK market peaked in June2007. Like the European and theUS equity markets, it staged apowerful bounce between March2009 and early 2010.

FUZ

8/8/2019 38029534-SG-Japan-US

15/16

Japan parallels

23 S ept emb er 2 010 15

What dif ferentiates the UK now from Ja pan then?

Similarities

Excess leverage The private sector took on excess leverage

in the pre-crisis period, fuelled by over optimism, financial

deregulation and a lax attitude to credit.

and asset prices bubbles Asset price bubbles resulted

from the situation above; eventually those bubbles burst.

Bank failures The crisis resulted in the failure of systemically

important financial institutions.


substantially due to the crisis, but are also burdened by

structural issues.

Reform The crisis has triggered deep-rooted reform of thefinancial sector.

Differences

Excess leverage, but not on corporate balance sheets UK

excess leverage is on household balance sheets.

Prompt policy response The UK policy response was bold and

fast, contrary to that of Japan.

The UK is committed to rapid fiscal repair The UK is planning

the tightest of the G4 fiscal policies.

Fa s t-track incre a se in th e hous ehold s avin gs rate

-2

0

2

4

6

8

1012

14

16

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Saving ratio


SG view The UK, in common with many other developed economies, has experienced the deepest

recession in post-war history. The economy is now recovering but this has come at a heavyprice. The legacy of the fiscal and monetary stimulus necessary to achieve that stabilisationand recovery will be with us for many years as the government struggles to reduce its debt

burden and the central bank ponders how to return to some kind of normal monetary policy.

FUZ

8/8/2019 38029534-SG-Japan-US

16/16

Japan parallels

The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this informationand any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information isprovided on an as is basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to,computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purposewith respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to,computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are servicesmarks of MSCI and its affiliates. or such similar language as may be provided by or approved in advance by MSCI.

IMPORTANT DISCLAIMER: The information herein is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities andincluding any expression of opinion, has been obtained from or is based upon sources believed to be reliable but is not guaranteed as to accuracy orcompleteness although Socit Gnrale (SG) believe it to be clear, fair and not misleading. SG, and their affiliated companies in the SG Group, may from timeto time deal in, profit from the trading of, hold or act as market-makers or act as advisers, brokers or bankers in relation to the securities, or derivatives thereof, ofpersons, firms or entities mentioned in this document or be represented on the board of such persons, firms or entities. Employees of SG, and their affiliatedcompanies in the SG Group, or individuals connected to then, other than the authors of this report, may from time to time have a position in or be holding any ofthe investments or related investments mentioned in this document. Each author of this report is not permitted to trade in or hold any of the investments or relatedinvestments which are the subject of this document. SG and their affiliated companies in the SG Group are under no obligation to d isclose or take account of thisdocument when advising or dealing with or for their customers. The views of SG reflected in this document may change without notice. To the maximum extentpossible at law, SG does not accept any liability whatsoever arising from the use of the material or information contained herein. Dealing in warrants and/orderivative products such as futures, options, and contracts for differences has specific risks and other significant aspects. You should not deal in theseproducts unless you understand their nature and the extent of your exposure to risk. This research document is not intended for use by or targeted at retailcustomers. Should a retail customer obtain a copy of this report they should not base their investment decisions solely on the basis of this document but mustseek independent financial advice.Important notice: The circumstances in which materials provided by SG Fixed & Forex Research, SG Commodity Research, SG Convertible Research and SGEquity Derivatives Research have been produced are such (for example because of reporting or remuneration structures or the physical location of the author ofthe material) that it is not appropriate to characterise it as independent investment research as referred to in European MIF directive and that it should be treatedas a marketing material even if it contains a research recommendation ( recommandation dinvestissement caractre promotionnel ). However, it must bemade clear that all publications issued by SG will be clear, fair, and not misleading.

Analyst Certification: Each author of this research report hereby certifies that (i) the views expressed in the research report accurately reflect his or her personalviews about any and all of the subject securities or issuers and (ii) no part of his or her compensation was, is, or will be related, directly or indirectly, to the specificrecommendations or views expressed in this report.Notice to French Investors: This publication is issued in France by or through Socit Gnrale ("SG") which is authorised by the CECEI and regulated by the

AMF (Autorit des Marchs Financiers).Notice to UK investors: This publication is issued in the United Kingdom by or through Socit Gnrale ("SG") London Branch which is regulated by theFinancial Services Authority ("FSA") for the conduct of its UK business.Notice To US Investors: This report is intended only for major US institutional investors pursuant to SEC Rule 15a-6. Any US person wishing to discuss thisreport or effect transactions in any security discussed herein should do so with or through SG Americas Securities, LLC (SGAS) 1221 Avenue of the Americas,New York, NY 10020. (212)-278-6000. THIS RESEARCH REPORT IS PRODUCED BY SOCIETE GENERALE AND NOT SGAS.Notice to Japanese Investors: This report is distributed in Japan by Socit Gnrale Securities (North Pacific) Ltd., Tokyo Branch, which is regulated by theFinancial Services Agency of Japan. The products mentioned in this report may not be eligible for sale in Japan and they may not be suitable for all types ofinvestors.Notice to Australian Investors : Socit Gnrale Australia Branch (ABN 71 092 516 286) (SG) takes responsibility for publishing this document. SG holds an

AFSL no. 236651 issued under the Corporations Act 2001 (Cth) ("Act"). The information contained in this newsletter is only directed to recipients who arewholesale clients as defined under the Act.IMPORTANT DISCLOSURES: Please refer to our website: http:\\www.sgresearch.socgen.comhttp://www.sgcib.com. Copyright: The Socit Gnrale Group 2010. All rights reserved.

38029534-SG-Japan-US

Documents

Transcript of 38029534-SG-Japan-US