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Shift from T-Bonds and into Commodities & Gold?Gary Dorsch For the past decade, prices in Japan have been stable or fallen, in an economy where the central bank has pegged its overnight loan rate near zero-percent, and where 10-year bond yields haven’t climbed above 2-percent. Between 1991 and 1995, Tokyo spent $2.1-trillion on public works, in an economy that’s less than half the size of the United States, in order to lift its economy out of a severe downturn caused by the bursting of a real estate and stock market bubble in the early 1990’s. By 1996, Japan’s economy started to rebound, growing at a +3% clip, but it was stymied by premature spending cuts and tax increases, due to concerns about ballooning budget deficits. In total, Japan spent $6.3-trillion on construction-related public investment between 1991 and September 2008. But while spending remained high, Japan never escaped its recurring bouts with deflation and recessions. Instead, Japan accumulated the largest public debt in the developed world, equaling 180% of its $5.5-trillion economy, - while failing to generate a sustainable recovery. The size of America’s $820-billion stimulus plan is far less than what Japan spent, and now that various programs are being phased-out, traders in the G-7 bond markets have begun to fear that the US-economy could stumble into a “double-dip” recession, leading to a Japanese style deflationary trap. As of May, Japan’s year-over-year core deflation rate stood at -1.6%, and in August, its 10-year government bond yield briefly slipped below 1%, for the first time in seven-years. If deflationary psychology takes hold among consumers, they’ll wait for still lower prices, before buying, adding to the deflationary spiral. And as Japan’s experience suggests, deflation can increase the financial pain of a traditional recession. When deflation strikes, lower sales prices cut into business profits and in turn, prompts companies to trim payrolls. That undermines consumers’ buying power, leading to a vicious cycle of more pressure on profits, jobs, and wages, - and cutbacks in purchases of new equipment. Likewise, bond yields can stay unbelievably low. The Fed has vowed not to make the same mistake as the Bank of Japan, which waited too long to ease its monetary policy in the early 1990’s. Taking note of Japan’s experience, the Fed pledged in March 2009, to buy $1.45-trillion of mortgage securities backed by Fannie Mae and Freddie Mac, and $300-billion of long-term Treasury bonds. During the Great Depression, the Fed allowed the money supply to fall rapidly, and consumer prices fell 10% between 1929 and 1933. On Sept 1st, Philadelphia Fed chief Charles Plosser said he would be open to further bond purchases if he saw deflation as a real risk. “I would certainly entertain the solution if I feared deflation, and if expectations were coming unglued in that direction. Then we would have to take actions,” he warned. Treasury bond traders should be careful for what they wish for. Soon after the Fed launched QE-1 in March 2009, the US-Treasury’s 10-year yield turned sharply higher, climbing from 2.60%, to as high as the impenetrable 4-percent level, just two months later.
Unleashing QE-1 ignited fears in the T-bond market of “too-much” money chasing “too-few” goods, that would unleash good, old-fashioned, – Inflation, - the magic elixir for debtors, but injurious for lenders. Sure enough, following a time lag of about four-months, the Rogers International Commodity Index, (RICI), containing a basket of 36-commodities, began to surge sharply higher on a year-over year basis, climbing from a reading of -54% in July 2009, to as high as +37% in Q’1, 2010. The upward surge in global commodity inflation and Treasury bond yields converged in Q’1, 2010. The RICI peaked at +49%, while the ten-year T-note yield peaked at 4-percent. At about the same time, the Fed was winding down QE-1, buying its last batch of MBS’s in March 2010. Since then, shockwaves from the Greek debt crisis, and a stoppage of the Fed’s money injections, helped trigger a sharp downturn in Treasury yields, and also knocked the commodity inflation into negative territory. For all the smug confidence about a sustainable economic recovery this year, sentiment turned upside down by August. The flavor of the month shifted 180-degrees to talk about a “double-dip” US-recession and a slide into a Japanese style deflationary trap. As Mark Twain used to say, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” When it comes to judging the true rate of inflation, an investor can choose to rely on government statistics, which are often fudged by apparatchiks, for political purposes, or an investor can observe the dollars and cents that move the commodities market, for real-time clues about the future direction of inflation or deflation. Using this simple rule of thumb, the RICI is now trading near a zero rate of inflation, signaling that the bond market’s fear of a deflationary trap is overblown.
In Japan, the central bank and the ministry of finance (MoF) manhandled the JGB’s 10-year yield within a narrow range between 1% and 2%, for the past seven years. Massive overdoses of liquidity injections over the years have left the $8.5-trillion JGB market dysfunctional. Still, it was of great interest, when 10-year JGB yields briefly slipped below the psychological 1%-level, in late August. The historic slide in Japanese bond yields mirrored the US-dollar’s slide to a 15-year low against the Japanese yen. Every time the US-dollar falls by 1-yen, it reduces Japanese exporter profits by about 0.90%, and weakens the Nikkei-225 index. The yen has risen 11% against the dollar so far this year, driven by safety-seeking flows lately on fears the US-economy may be sliding into a “double-dip” recession, and worries that Greece might ask for a restructuring of its debts. Yields on Japan’s 30-year bonds briefly fell below the 20-year yield, - projecting a flat yield curve, and sliding to the fault line of a highly dangerous inverted curve. “Currency rates have come to a critical juncture,” warned Japan’s deputy banking chief Kohei Otsuka on August 11th. “A rapid yen rise would boost deflationary factors, so the government and BOJ must act as one in considering our commitment to act against deflation,” he said. On August 27th, Japan’s Prime-minister Kan vowed to take strong measures to stop the dollar’s slide against the yen. On August 30th, the BOJ tried to stop the US-dollar’s slide, by boosting its deposits in the local banking system to 30-trillion yen ($350-billion), up from 20-trillion yen previously. Increasing the supply of yen briefly boosted the US-dollar to as high as 86-yen. The Fed’s decision to delay QE-2 for awhile longer, also gave the US-dollar some respite from bearish currency speculators. However, the intervention effort fizzled, and within a few days, the US-dollar tumbled to 83.50-yen. On Sept 7th, Japanese Finance chief Yoshihiko Noda said Tokyo would take decisive steps to cap the yen’s rise, including intervening in the FX market to weaken the yen.
Ironically, the biggest reaction to the BoJ’s injection of an extra 10-trillion yen, was in the JGB market, where ten-year yields boomeranged, and spiked upwards to as high as 1.20%, marking a 30-basis point jump from a low of 0.90% hit in late August. Traders have long memories of the bursting of the JGB bubble in the second half of 2003, that saw yields ratchet upwards from a record low of 0.53% to as high as 1.65% within four-months. Already, investors who locked-in JGB 10-year yields below 1% last month, have suffered a 2% capital loss over the past few days. Trying to push ultra-low JGB yields even lower is like trying to push a helium balloon under water. In order for JGB 10-year yields to stay below 1%, the deflation rate in Japan must average a negative 2-percent. There is an absolute limit to how far long-term bond yields can fall, and with the BoJ’s overnight loan rate pegged at 0.10%, the probability of an inverted yield curve is near zero-percent. Only foreigners can still make money in JGB’s if the yen continues to climb higher the Euro and US-dollar. But the yen’s potential gains from here would be much tougher, if Tokyo’s financial warlords are prepared to engage in full-scale battle. To read the rest of this article, please click on the hyper-link below: http://sirchartsalot.com/article.php?id=143
### Gary Dorsch 321gold Ltd |
