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Japanese Bonds sell off Macro Economic Research May 2013

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When the BoJ announced their stimulus programme on the 4 th of April, Japanese bonds spiked

higher in anticipation of the $75bn a month of purchases, with yields reaching as low as 33

basis points. Yields are currently 85bps, having sold off a massive 35bps in the last 3 trading

days.

The 10 year bond future, after many years of slumber, has suddenly rediscovered volatility.

Japanese financial intermediaries collectively had some 30% of their assets invested directly in

their governments bonds as at 12/2012 (BoJ Flow of Funds). Japanese households have

indirect exposures (mainly via their life policies and pension funds) of more than 20% of their

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Japanese Bonds sell off Macro Economic Research May 2013

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financial assets (the second largest asset after an incredible 55% of financial assets in bank

deposits).

That bonds are being sold off despite the on-going massive intervention is a clear sign that the

BoJs 2% inflation in 2 years target is gaining credibility. I believe the biggest disconnect in the

Japanese market is an inability to answer the question I f inf lat ion gets to 2% wh at should

the real yield on b onds be? Real yields based on the 10 year bond yield less the YoY CPI

are currently 176bps for JGBs (shown below) and 44bps for USTs. JGB real yields have

briefly spiked negative only twice. A negative real yield of -0.5% and a 2% CPI still imply a

massive sell off in JGBs. A similar question can be asked for US bonds, again highlighting the

difficulties of pricing in the end of QE.

I believe that given the massive skew in existing positioning in financial assets by householdsand institutions, they must rotate out of bonds and bank deposits into equities and foreignsecurities. Every dip in equities will be bought, every rally in the bonds sold, until the credibilityof the BoJs 2% in 2 years target is established or destroyed.

Kevin Cousins is a portfolio manager at Brait Capital Management Limited. ("BraitCM"). This article is prepared byKevin as an outside business activity. As such, BraitCM does not review or approve materials presented herein. Theopinions and any recommendations expressed in this article are those of the author and do not reflect the opinions orrecommendations of BraitCM. None of the information or opinions expressed in this article constitutes a solicitationfor the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice andany recommendations that may be contained herein have not been based upon a consideration of the investmentobjectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in anysecurities or other instrument should be based upon your own analysis and conclusions. Either BraitCM or KevinCousins may hold or control long or short positions in the securities or instruments mentioned.