Bond Wars: Chinese Advisor Calls For Japanese Bond Dump Reply

Earlier today we casually wondered whether the US stands to lose more by supporting China or Japan in their escalating diplomatic spat, considering the threat of a US Treasury sell off is certainly not negligible, a dilemma complicated by the fact that as today’s TIC data indicated both nations own almost the same amount of US paper, just over $1.1 trillion. In a stunning turn of events, it appears that China has taken our thought experiment a step further and as the Telegraph’s Ambrose Evans-Pritchard reports, based on a recommendation by Jin Baisong from the Chinese Academy of International Trade (a branch of the commerce ministry) China is actively considering “using its power as Japan’s biggest creditor with $230bn (£141bn) of bonds to “impose sanctions on Japan in the most effective manner” and bring Tokyo’s festering fiscal crisis to a head.” I.e., dump Japan’s bonds en masse.

Should this stunning recommendation be enacted, not only would it be the first time in world history that insurmountable credit is used as a weapon of retaliation, it would mark a clear phase transition in the evolution of modern warfare: from outright military incursions, to FX wars, to trade wars, culminating with “bond wars” which could in the span of minutes cripple the entire Japanese fiscal house of cards still standing solely due to the myth that unserviceable debt can be pushed off into perpetuity (as previously discussed here).

Not needing further explanation is the reality that should China commence a wholesale Japanese bond dump, it may well lead to that long anticipated Japanese bond market collapse, as creditor after creditor proceeds to sell into a market in which the BOJ is the buyer of only resort in the best case, and into a bidless market in the worst.

The immediate outcome would be soaring inflation as the BOJ is forced to monetize debt for dear life, buying up first hundreds of billions, then trillions in the secondary market to avoid a complete rout, matched by trillions of reserves created out of thin air which may or may not be halted by the Japanese deflationary gate, and which most certainly could waterfall into the economy especially if Japanese citizens take this as an all clear signal that the Japanese economy is about to be crippled in all out economic warfare with the most dangerous such opponent, and one which just defected from the “global insolvent creditor” game of Mutual Assured Destruction.

Further complicating things is that Japan has no clear means of retaliation: it owns no Chinese bonds of its own it can dump as a containment measure. Instead, Japan is at best left with the threat of damages incurred on the Chinese economy should Japan be lost as a trading parting. It appears, however, that to China such a gambit is no longer a major concern:

Mr Jin said China can afford to sacrifice its “low-value-added” exports to Japan at a small cost. By contrast, Japan relies on Chinese demand to keep its economy afloat and stave off “irreversible” decline.


“It’s clear that China can deal a heavy blow to the Japanese economy without hurting itself too much,” he said. It is unclear whether he was speaking with the full backing of the Politburo or whether sales of Japanese debt would do much damage. The Bank of Japan could counter the move with bond purchases. Any weakening of the yen would be welcome.

Yes, but any offsetting Japanese hyperinflation would not, which is precisely what would happen if after 30+ years of dormancy the Japanese bond vigilantes were woken up by none other than a cuddly Panda bear with very murderous intentions.

Ironically, this terminal bond war escalation would also mean that Japan’s last ditch alternative is to threaten the US with dumping America’s bonds in turn if the US i) does not step up on behalf of Japan and ii) if Japan is forced to promptly convert debt from one denomination into another. The fallout effect would be most dramatic.

It is unclear if China will proceed with this “scorched bond” step: should this happen there is likely no turning back as it would force a market test of the entire developed world. And as our readers know all too well, the entire developed world is insolvent, and the only reason why it has perpetuated the illustion that all is well, is because being a closed system, nobody has the incentive to defect. Until now that is, when suddenly over a piece of rock in the East China Sea, China may find itself pulling the pin on the global debt grenade.

And even if this is not the final denouement, the market appears to already be pricing in several not much more favorable outcomes:

Markets are already starting to price in an arms race in Asia. Shares of China’s North Navigation Control Technology, which makes missile systems, have jumped 30pc in recent days.


China is becoming self-sufficient in defence. It was the world’s biggest net importer of weapons six years ago. It fell to fourth place last year.


Japan is at the other extreme. An official report this year – “A Strategy for Survival” – said Japan’s spending on its “Self-Defence Force” had shrunk by 4pc in 10 years. It called for “urgent” action to rebuild the country’s military.

One thing here is certain: Japan picked on the wrong country when two weeks ago it “purchased” the disputed Senkaku Islands. If it thought that China would just forgive and forget with a wink, it was dead wrong.

It now has several two options: undo all that has happened in the past fortnight, in the process suffering tremendous diplomatic humiliation, leaving Senkaku in the “no man’s land” where they belong, or push on, and suffer the consequences. And the consequences for the country represented by the question market in the chart below, would be tragically severe, as would they for the entire “developed”, insolvent and daisy-chained world


Source: Zerohedge


It’s Just Getting Stupid! Reply

As Cantor’s Peter Cecchini notes today:

“when things are this senseless, a reversion to sensibility will occur again at some point.”

His view is to be long vol and as the disconnect between the economic cycle and stocks continues to grow, we present three mind-numbing charts of the exuberant hopefulness that is now priced in (oh yeah, aside from AAPL actually selling some iPhones in pre-order). Whether it is earnings hockey-sticks, global growth ramps, or fiscal cliff resolutions, it seems the market can only see the silver-lining. We temper that extreme bullish view with the fact that all the monetary policy good news has to be out now – for Ben hath made it so with QEternity.

These three factors – weak economic growth, powerful monetary policy and elevated public policy uncertainty – remain the critical drivers of performance and with weakening data, the market is all the more dependent on central bank life support – and following the rally through the Fed signalling period to 1460, much of the monetary policy related rally seems to be priced in, with the market already discounting considerable data improvement. With already high oil, gasoline and food prices, the Fed’s balance sheet expansion risks driving down the dollar, boosting commodities and dampening consumption and thus growth.  

As this chart comparing P/E multiples to the ISM New Orders index, we need to see some serious unicorn-conjuring for these valuations to be sustained…


One tool often utilized to assess the attractiveness of equities relative to other assets is the equity risk premium (ERP), also known as the Fed model or the difference between the forward earnings yield and the yield on the 10 year U.S. Treasury. We have argued, based in part on the prior period of extreme financial repression in the U.S. following WWII, that a sustained contraction in the ERP and expansion of the PE multiple was unlikely until the Fed began the policy normalization process. Integrating inflation and a ratio of stock to bond market volatility paints a far less compelling picture for equity market valuation. We are at least 3 years from any normalization of Fed policy (according to them) and thus…

the following chart (or real rates vs P/E multiples) suggests current valuations are unsustainable at best, or down-right crash-worthy as you simply can’t fight the cash-flow forever…



The reach for yield and safety has led investors to push into mega caps – defensive ingredients including lower betas, lower earnings volatility, and lower P/E multiples as well as higher dividend yields. This has pushed the relative median P/E of the mega caps notably above smaller (and higher beta) stocks – as the somewhat odd beta-defying rally of the last few weeks took hold

Our point here is that 1) the spread between LTM and NTM PE is gaping (something that we saw in the run-up to the peak in 2008), and 2) that the mega-caps which dominate the indices (which everyone watches including Ben) are ‘over-valued’ rightly or wrongly relative to less-defensive stocks… leaving plenty of room for rotational risk-off as well as reality disconnects



On balance, Barclays are less bullish than they were at this time in either of the last 2 years. Investors seem to mis-remember history; monetary policy was not the only driver of the rallies following QE2 and Operation Twist. In the signalling period prior to QE2’s launch, and in the immediate aftermath of its commencement, both the economic and public policy outlooks were improving.

[They] remain relatively cautious given a weaker economic outlook and no clear trend in the polls to provide confidence that the U.S. can avoid the potential massive tax hike scheduled for January 1, 2013


Source: Zerohedge


Spain is Greece… Only Bigger and Worse

Phoenix Capital Research's picture

Submitted by Phoenix Capital Research on 09/16/2012 20:42 -0400

Swing by for more market commentary, investment strategies, and several FREE reports devoted to help you navigate the coming economic and capital market changes safely.


As I’ve outlined in earlier articles, Spain will be the straw that breaks the EU’s back. The country’s private Debt to GDP is above 300%. Spanish banks are loaded with toxic debts courtesy of a housing bubble that makes the US’s look like a small bump in comparison. And the Spanish government is bankrupt as well.


Indeed, in the last month alone we’ve seen:


  1. Spain’s banking system saw a bank run to the tune of €70 billion in August. The market cap for all of Spain’s banks is just €114 billion. So Spanish banks need to raise at least €20+ billion or so per month in the coming months to stay afloat. This is without depositors pulling additional funds in September onwards. That’s really bad news.


  1. Spain’s now nationalized Bankia just took another €5.4 billion from Spain’s in-country rescue fund. This indicates that once nationalized, problem banks DO NOT cease to be problems.


  1. The region of Andalusia is requesting a bailout from the Spanish Federal Government. This comes on the heels of bailout requests from the regions of Valencia, Murcia and Catalonia (none of which want any “conditions” on the funds).


  1. Spain has set aside €18 billion to bailout its regions. The current bailout requests already amount to €10.8 billion. That’s just from this year alone.


If you need more info on Spain, the bullet items from them that you need to know are that:


  1. A huge portion of Spain’s banking system (representing over 50% of mortgage loans AND deposits) was totally unregulated up until just a few years ago.
  2. Spanish banks were drawing €337 billion from the ECB on a monthly basis to fund their liquidity needs.
  3. Every political figure and bank in Spain is HIGHLY incentivized to lie about the true nature of the Spanish banking system (a private text message from the Prime Minister claimed the REAL capital needs were closer to €500 billion… which is assuming he knows what he’s talking about/ the banks were honest with him… which I HIGHLY doubt).


Indeed, the markets are beginning to figure out the Spain is DONE regardless of what the ECB does. The truth is that Spain is in as bad a shape as Greece if not worse. Expect things to get very, very ugly soon.


The reason is two fold:


  1. Spanish banks need to roll over (meaning renew terms on) more than 20% of their bonds this year.
  2. Spanish sovereign bonds are collateral for hundreds of billions of Euros’ worth of trades.


With Spanish banks already under severe funding stress (again, they drew €337 billion from the ECB before the new OMT program… and depositors took €70 billion out of the system last month), they’re in no position to start paying out higher interest payments to bondholders.


And with investors realizing that Spain’s banks are all lying about the state of their balance sheets (remember, Bankia was talking about paying a dividendjust one month before it collapsed and revised its €41 million 2011 profit to a €3.3 billion LOSS), we’re going to be seeing plenty of bank failures this year.


Remember, Spain’s initial request was for the EU to bail out its banks NOT the country itself. However, with some six Spanish regions (probably more) looking for bailouts Spain is now facing both a sovereign debt AND a banking crisis.


The timing of this issue will be difficult due to the ECB’s intervention, but at the end of the day, the math doesn’t add up. Spain has big problems and when the market figures out that the ECB cannot solve them… it’s going to be a very difficult time in Europe.


Source: Zerohedge

The One Chart To Explain The Real Effect Of QE3 Reply

Much has been written over the course of the last few days/weeks about what Bernanke could do, has done, and the efficacy of said actions. Inflation, unintended ‘energy’ consequences, debasement, financial repression, scarcity transmission mechanisms all come to mind but realistically they are all just symptoms of what is really going on. As the following chart from Barclays shows, the real effect of LSAPs is to suppress the signaling effect of macro data from the real economy. During periods of extreme monetary policy, the stock market’s beta to macro-economic data surprises is dampened massively – and hence the forced mal-investment and mis-allocation of funds occurs. However, given the now open-ended nature of QE3, this may change with the ‘good news/bad news’ logic leading to a stronger market (higher beta) response (since all bad news is automatically attenuated by QEternity and thus all the good news is out there).


Via Barclays:

An important driver of this attenuated market response to economic news was the sense that important elements of the monetary policy framework were ‘in play’, and that policy was likely to respond if the economy weakened sufficiently, but not otherwise. In this context, bad economic news may not seem so horrible, if it is perceived to raise the probability of a market-friendly monetary policy response. In the run-up to June 2011, the question facing investors was whether the Fed would allow QE2 to end in June, in accord with the Fed’s stated intention. More recently, the question has been whether the Fed would put a more aggressive policy in place. But the ‘good news/bad news’ logic was much the same.


It seems to us that this logic will not, however, remain operative in the months to come, since the policy frameworks recently announced by both the Fed and the ECB have no stated end date on which markets can focus (as did QE2), and are not likely to be materially adjusted in response to economic data for some months to come. Economic news may have been a ‘good news/bad news’ story in the recent past. But now that the monetary policy responses to economic weakness are in place, markets have had the good news.

In the future, bad economic data will be, well, just bad, and good news will be unambiguously positive. This should lead to a stronger market response to economic data in the weeks and months to come.


Source: Zerohedge

The Fed’s Drugs Won’t Work Anymore Reply

QE3. No QE3. The markets have been injected with this hopium for months and have been let down on every occasion except for this last one. The Fed’s issuance of this last round of quantitative easing has rendered future doses of this drug ineffective.

It was explicitly stated that the Fed would issue QE as needed in unlimited amounts until the market is able to create enough jobs to stimulate dramatic growth. This means that there will not likely be any future spikes in the market as a result of another QE announcement…the market no longer questions whether or not more drugs will come, now they expect them.

The Fed had been using “QE hype” to rally the markets. Every time we were on the verge of a collapse another QE announcement would be made bringing us a few feet back from the fiscal cliff. But that tactic wont work anymore…

The Fed’s actions are fiscally irresponsible and the U.S. will quickly suffer the consequences of this poor decision. If the economic change needed to return to growth is structural then a monetary fix, or QE, isn’t the remedy.

The U.S. Dollar is on the decline against other major currencies, and investors are losing confidence in the Fed’s ability to manage the ensuing risk of another recession. Question that remains, what happens when the QE drug gets taken away?

It’s time to hedge; if the value of the U.S. dollar collapses how will you respond? Diversification is key. Learn to manage your risk by looking a head; join the Forward Thinking waiting list now.

Your currency analyst,

Justin Burkhardt

source: Zerohedge

Carry Trade Loss 2.8% as Dollar Fails to Weaken on Fed Reply

By Monami Yui, Masaki Kondo and Hiroko Komiya – Sep 10, 2012 9:42 AM ET

Central bankers will get a lot less bang for their buck, pound, euro and yen as they struggle to stimulate flagging economies, trading strategies in the $4 trillion a day foreign-exchange market suggest.

The UBS AG V24 Carry Index, which measures returns from borrowing in lower-rate currencies to buy higher-yielding ones for so-called carry trades, has fallen 2.8 percent from a four- month high on Aug. 9. Bloomberg Correlation-Weighted Indexes show that the worst-performing major currency in the past month was the Australian dollar, typically a beneficiary when investors are bullish on the economy because the nation has the highest interest rates among developed economies.

From the $2.3 trillion pumped into the U.S. by the Fed since 2008 to record-low interest rates in the euro zone, U.K. and Japan, nothing has prevented the world’s economy from slowing this year. Foreign-exchange traders are signaling they expect little improvement any time soon, and that’s a change from the past. After Chairman Ben S. Bernanke flagged $600 billion of quantitative easing, or QE, in August 2010, the carry trade gained 3.1 percent in 30 days.

“I can’t be optimistic that investor sentiment will improve rapidly and the world’s economy will pick up,” Yoshisada Ishide, who oversees $14 billion as the manager of the biggest mutual fund focused on Australian dollar-denominated debt at Daiwa SB Investments Ltd. in Tokyo, said in a phone interview on Sept. 7.

That outlook echoes Yale University professor Stephen Roach and Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. They say central bank money printing is losing its effectiveness in spurring growth.

‘Excessive Fat’

“I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy,” Roach, the former non-executive chairman for Morgan Stanley in Asia, said in a Bloomberg Television interview on Sept. 6.

“Our credit-based financial system is burdened by excessive fat and interest rates that are too low,” Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthlycommentary posted on Pimco’s website Sept. 5.

Falling demand for commodity imports in China sent the Australian dollar down 3.6 percent over the past month, the biggest drop among the 10 developed-nation currencies tracked by the Bloomberg indexes. That contributed to a 9 percent decline since August 2011 for carry trades funded by the dollar and invested in the so-called Aussie, South African rand, Brazilian real and Mexican peso.

Strategy Reversal

Carry trades had returned almost 80 percent from March 2009 through July last year as investors took advantage of lower borrowing costs in developed markets to buy assets in emerging and resource-producing nations. Benchmark interest rates in the Group of 10 will average about 0.53 percent this year, compared with 6.39 percent for Brazil, Russia, India and China, according to data compiled by Bloomberg.

The dollar sank 1 percent last week according to the Bloomberg index, after the U.S. Labor Department said the economy added 96,000 jobs in August, below the 130,000 median estimate of 92 economists surveyed by Bloomberg. The dollar advanced 0.2 percent to $1.2793 per euro as of 8:40 a.m. in Tokyo. It was little changed at 78.23 yen.

Concerns that growth will continue to deteriorate gives the Fed room to signal a third round of bond purchases as early as this week. A gauge of indicators used to measure expectations for Fed stimulus rose to 99 percent in August, the highest ever, according to Citigroup Inc.

Policy makers began injecting money into their economies after the collapse of Lehman Brothers Holdings Inc. four years ago this week sparked the biggest financial crisis since the Great Depression.

Global Stimulus

After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the European Central Bankprovided 442 billion euros ($566 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.

The unprecedented actions came with interest rates already at or about record lows. The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.

Dollar Falls

Fed stimulus has typically debased the currency. IntercontinentalExchange Inc.’s Dollar Index (DXY) tracking the greenback against six U.S. trading partners, dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011.

That might not happen this time. While the index fell 2.4 percent in the last month to 80.25, it’s still within 5 percent of a two-year high of 84.10 reached on July 24. Bloomberg Correlation-Weighted Indexes show New Zealand’s currency weakened 2.3 percent in the past month, the biggest decline after the so-called Aussie dollar.

The political backlash over QE has been fierce. Republicans called for an audit of the Fed in their 2012 platform adopted in Tampa, Florida, on Aug. 28. Senator Bob Corker of Tennessee said in a press release Sept. 6 that an “unhealthy obsession” with monetary policy is distracting the public from the need for fiscal reform. The Fed’s balance sheet has swelled by almost threefold since the collapse of Lehman to $2.81 trillion.

“We’re seeing clearer signs of diminishing returns from success of quantitative easing programs,” Robert Rennie, chief currency strategist at Sydney-based Westpac Banking Corp., Australia’s second-largest lender, said in a telephone interview on Sept. 5.

Stocks Rally

Carry trades may benefit from a resolution for Europe’s debt turmoil. Prospects for a cure rose when ECB President Mario Draghi announced on Sept. 6 an unlimited bond-buying program to damp yields in the euro area and fight speculation that Greece might leave the 17-nation currency union. Purchases will be sterilized, meaning the money supply won’t grow.

Global stocks and riskier currencies rallied. The 17-nation euro strengthened 1.9 percent last week to $1.2816, the highest closing level since May 21, while the Australian dollar added 0.6 percent to $1.0385. The MSCI World Index (MXWO) jumped 2.6 percent in the five days through Sept. 7 to a five-month high.

“We’re pretty bearish on the dollar,” Mary Nicola, a New York-based currency strategist at BNP Paribas SA, France’s largest bank, said Sept. 5 in a telephone interview. “We see weakness against the commodity currencies.”

China Slows

BNP estimates the Dollar Index may fall to 76.4 by the end of June, the lowest projection among 10 analysts in a Bloomberg survey. The median of their forecasts signal the gauge will advance to 82.4.

Signs that China is losing steam may dent economies such as Australia that depend on the world’s second-largest economy to buy their commodities.

Manufacturing contracted in China at the fastest pace in August since March 2009, according to the purchasing managers’ index released by HSBC Holdings Plc and Markit Economics on Sept. 3.

Even a calming of currency price swings that normally would benefit the carry trade is having little effect. The JPMorgan G7 Volatility Index fell to 8.03 percent on Sept. 7, the lowest since October 2007, and down from its record 26.55 percent in October 2008. A smaller number means the potential profit from carry trades is more predictable, boosting the allure of the strategy.

Awaiting Storm

“Volatility is low simply because people are staying on the sidelines, awaiting the next storm,” Masashi Murata, a currency strategist in Tokyo at Brown Brothers Harriman & Co., said in a telephone interview on Sept. 6. “Conditions for carry trades aren’t being met.”

The U.S. may tip into recession next year if lawmakers can’t break an impasse over the federal budget, according to report from the nonpartisan Congressional Budget Office. Economic output would shrink next year by 0.5 percent, and joblessness would climb to about 9 percent, unless $600 billion in scheduled tax increases and spending cuts are halted, the CBO said Aug. 22.

‘Weakest Recovery’

“What the record shows is we’ve had the weakest recovery on record, we have anunemployment rate above 8 percent, and the U.S. consumer is basically dead in the water,” Yale’s Roach said on Bloomberg Television’s “First Up” with Susan Li.

The rest of the developed world isn’t much better off. The euro-zone and U.K. economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake.

New regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated, Gross wrote in the monthly commentary posted on Pimco’s website Sept. 5.

“Returns from both stocks and bonds will be stunted,” Gross said. “Central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result.”

To contact the reporters on this story: Monami Yui in Tokyo at; Masaki Kondo in Singapore at; Hiroko Komiya in Tokyo


Source: Bloomberg