Friday June 18, 2004 - 19:11:13 GMT
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Foreign Exhcange Analytics: Stay Short JGB's But Watch For July PBOC Rate Hike
Stay Short JGB's But Watch For July PBOC Rate Hike
The one macro trade that has been paying off reasonably well is short JGB's as yields hit new 3.5-year highs almost daily. Japan's economy appears to be getting back on track with more than simply rising exports fueling growth. Capex and consumer spending (more the former) are helping to reawaken a domestic economy. Firm profits are up as well and in many cases employees are set to be paid summer bonuses for the first time en masse in a while. In a market devoid of clear directional trades, selling JGB's is one very clear trade.
But like any market, trades get crowded and this one is beginning to look a bet busy. In terms of yields, MoF, and to a lesser extent the BoJ, is not pleased with some of the back up in yields. Remember banks are recapitalizing by borrowing overnight funds near zero and buying JGB's. The ability of the banking system to write off bad loans depends on recapitalizing via spread trades. The back up in yields has exposed the banking system to some serious capital losses on long JGB positions. And it could pressure government debt servicing costs, though there is some offset from higher tax receipts generated by a stronger growth rate.
And Japan has a long stock trade that goes with a short JGB trade, though clearly this side of the same coin traded well before JGB's sold off. Bit longer toothed than short JGB's but both ride on a recovering economy story.
So what is wrong with JGB short? For the time being nothing. MoF can and does manipulate the yen. It has hardly any means for manipulating JGB's short of enlisting the BoJ to buy them and this is the business of the BoJ...monetizing the deficit and not easily finessed.
It is a rate hike in China that poses the greatest risk to the JGB shorts (and Nikkei longs). PBOC met today but refrained from signaling its intentions on interest rates. However, top officials have made it clear that a rate hike will be needed if CPI hits 5%. It hit 4.4% in May and 3.8% in April. In other words 5.0% in June would be in keeping with the recent pace of acceleration. The June CPI report should be out in the second week of July, making a rate hike likely. Sure a rate hike in China is not the end point of the Japanese expansion. But it should call into question the ability of China to drive the region's GDP (exports). China is serious about avoiding an overheating and is equally serious about avoiding a hard landing. Measures taken to date to trim bank lending, steel consumption and real estate speculation are effective. But more needs to be done and July should see the first step by China to raise rates since 1995.
So beware of a decent short cover rally in JGB's (Nikkei sell-off, yen sell-off) on a July rate hike by PBOC. Until then the trade carries a higher level of confidence than most.
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