Great Chart: US Yield Curves: 5Y30Y vs. 3M10Y

On Friday (March 22nd), the disappointing German PMIs led to little sell-off in global equities and a rise in risk-off assets such as government bonds and safe-haven currencies (i.e. JPY, CHF). For the past month, we have been warning that the elevated uncertainty in addition to the low level of global yields were challenging the healthiness of the equity recovery since the beginning of the year. Moreover, fundamentals have been fairly weak overall (in the US, China and even in the Euro area), with leading economic indicators diverging from equities’ performance. For instance, many indicators have been pricing in a slowdown in the US economic activity, however the SP500 index is up approximately 14 percent year-to-date and trading 100pts short from its all-time highs reached in the end of September last year.

With the German 10Y yield falling in the negative territory, the amount of debt trading below 0 percent reached $10tr, up $2tr since the beginning of the year. In addition, the divergence between the 3M10Y and 5Y30Y yield curved have continued; while the 3M10Y turned negative (gaining all the market’s attention), the 5Y30Y has been trending higher in recent months, up 40bps to 66bps in the past 6 months. In this great chart, we can notice an interesting observation: each time the 5Y30Y has started to steepen before the end of the economic cycle, the 3M10Y followed the move 6 months later. We know that the critical moment of the business cycle is when the yield curve is starting to steepen dramatically. Hence, should we worry about the steepening of the 5Y30Y?

Chart. 3M10Y vs. 5Y30Y (6M Lead) – Source: Eikon Reuters

US yield

Japan and the Yen, where do we stand now?

On October 31st, Governor Kuroda announced that the BoJ will raise (by a 5-4 majority vote) its bond-buying program. We saw the reaction since then; USDJPY soared from 112+ then to 120 (with a high of 121.86 on December 7). Some analysts think that the move was/is exaggerated, but if you put the figures on table, it looks reasonable to me. By announcing that the Bank of Japan will buy between 8 and 12 trillion JPY of JGBs each month, it means that it will purchase the total 10tr Yen of new bonds issued by the Ministry of Finance; in other words, full monetization. As a reminder, the central bank is the largest single holder of JGBs (with 20%+ of the shares), and could end up owing half of the JP bond market within the next 3 to 4 years.

With the country now in a triple-dip recession (GDP contracted by 1.9% in the third quarter) and the inflation rate slowing down for the fourth consecutive month in November (core CPI, which excludes volatile fresh food but include oil products, rose 2.7% in November, down from 2.9% in September and 3% in October), I see just more ‘power’ coming from Japanese policymakers. Elected in December 2012 as Japan PM (the seventh one in the last decade), I am convinced that Abe (and Kuroda/Aso) cannot fail this time and will (and must) continue to go ‘all-in- on his plan. That will mean aggressive easing, therefore constant depreciation of the currency JPY in the MT/LT. Remember the graph I like to watch: Central Bank’s total assets as a percent of the country’s GDP (see article It is all about CBs).

In fact, as many analysts have stated, the hit from the sales tax increase back in April turned out to be bigger than expected. The second one, which was set for October 2015 and would have seen a 2-percent rise to 10 percent, has already been postponed for early 2017 according to Abe’s announcement last month. When will the country work on its budget balance? As a reminder, Japan has been showing a 8%+ budget deficit over the past six years, which rose the level of its debt to a ‘unsustainable’ 230% as a share of GDP.

Another major problem that the third-largest economy will have to deal with in the long term is its population. The chart below (Source: the Economist) shows the evolution of Japan’s population from 1950 to 2055 (forecast). It is aging, and that is terrible news for all the pension or mutual funds as many people from the Japanese workforce will switch from being net savers to net spenders.

20141213_gdc700(Source: the Economist)

With a population of 127 million in 2013, the number of people is expected to fall below 100 million by the middle of this century due to the low birth of rate (total fertility rate of 1.4 in 2013).

In my article last month on the Japanese Yen History, I added a quick ‘technical’ chart and stated that we may see some take profit a 120 and that the pair should stabilize at around that level based on the downtrend line. And each time I have some discussion about the Yen, I always say there are two ways to play it:
– either keep it short (against USD or GBP) for those who are looking for a medium or long term view;
– or buy the pair (USDJPY) on dips if you try to catch nice trends. Don’t try to short it, unless you are really confident and have been doing it for a while. All traders I know are looking for buying opportunities on the pair.

Speaking of that, it looks to me that the core portfolio I have been carrying over the past few months now – Short EUR (1/2) , JPY (1/2) vs. long USD (2/3) and GBP (1/3) – has been quite profitable, and I still believe there is more room. At least, it makes sense on the idea I had about ‘monetary policy divergence’, with the US and UK considering raising rates (no printing/QE) while EZ and Japan aggressively printing with NIRP/ZIRP monetary policies. I will try to write a piece shortly on the Euro while I am working on my 2015 outlook.

Euro Zone under pressure

 After a contraction of -0.1% in Q1, Italy reported unexpectedly a 0.2% contraction (first estimates) in the second quarter (vs. consensus of +0.2%). The 10-year yield is now trading at 2.78%, 10bps higher than last week’s low of

It seems that the European Recovery is already over…

Eurostoxx under pressure
Watch the second lower trend line on Eurostoxx 50 as European banks will remain under pressure in the weeks ahead with investors still fearing further write-offs. As you can see it on the chart below, the next support on the downside stands at 3,000, which could lead to a further correction if it breaks it.

ES50

(Source: Reuters)

As you know, European banks are still in the middle of an AQR – Asset quality review – with the results to be unveiled in late October, slightly before the ECB takes over as the EZ official banking regulator on November 4. Some of the people refer the AQR as a form of stress test, and the question investors are asking themselves is if this ‘stress test’ will be effective.

 However, remember smth: back in 2011, a similar exercise was done by EBA (European Banking Authority). Dexia passed the test and then had to be bailed out three months later…

EURUSD remains also under pressure and is now trading slightly below the 50% Fibo retracement (1.2750 – 1.4000). Next support on the downside stands at 1.3300.

EURUSD

(Source: Reuters)