Takeaway: The political calendar poses a great deal of risk to the Japanese economy, JGBs and Japanese financial institutions over the next ~2 months.

Earlier today, Japan’s lower house of parliament (a.k.a. the Diet) passed a bill authorizing the sale of ¥38.3 trillion of JGBs to cover ~40% of already-approved FY12 expenditures, which began on APR 1st. While no set limit exists, this motion is akin to the US’s own statutory debt ceiling and, like our own debt ceiling, Japan’s deficit financing legislation allows for minority parties to have a say in the accumulation of sovereign debt.


Enter the LDP, Japan’s primary minority party in the more relevant lower house (House of Representatives – 120 of 480 seats) and a slight minority in  the upper house (House of Councillors – 87 of 242 seats) where no party has formed an outright majority. They have signaled as recently as last week that they will not approve the bill unless Prime Minster Yoshihiko Noda calls new elections, which would be roughly one year early, as they are officially due by AUG ’13. As it stands, neither party looks to dominate in the event of a snap election; both the DPJ and LDP have a paltry 13% approval rating per an Asahi poll released earlier this month.


This marks the latest political ploy for the LDP to regain political power in Japan, having recently backed off using the now-ratified VAT hike bill as collateral for Noda’s head. Members of the LDP remain broadly bitter about their party’s AUG ’09 defeat to the DPJ – which was architected by the now-defected Ichiro Ozawa – and they continue to look aggressively for opportunities to restore their long-time position atop Japan’s political hierarchy. Needless to say, we’d be remiss to dismiss these threats as mere political wrangling. Per Finance Minister Jun Azumi’s latest projections, the Japanese government will run out of cash sometime in October if this bill isn’t ratified in time.


The ramifications of a potential/actual Japanese government shutdown are three-fold:

  1. A potential sovereign default;
  2. A potential sovereign credit rating downgrade(s); and
  3. An associated $75-80 billion capital call across the Japanese banking system in the event JGBs are downgraded to single-A level by Moody’s and/or Standard and Poor’s, where the outlook is already “negative”.

To point #1, we do not see material risk of a JGB default over the intermediate term, despite debt service compromising roughly one-fourth of FY12 federal expenditures. Rather, we anticipate that Japanese lawmakers will either find a clause(s) within Japanese statue to completely circumvent a near-term default or they’ll cobble together some political compromise under the increasing scrutiny of global financial markets and ratings agencies. Either way, we don’t view a JGB default as a probable  risk over the next couple of months, as indicated by Japan’s sovereign CDS:




Unlike point #1, we do view point #2 as a heightened and increasingly-probable risk over the intermediate term. Per Takahira Ogawa, S&P’s director of sovereign ratings in Singapore, “political risk is the biggest negative for Japan’s rating”. In and of themselves, neither political risk nor an incremental downgrade of Japanese sovereign debt should do much to the historically-bulletproof JGB marketplace, which continues to have demand buoyed by surplus liquidity in the banking system that gets parked largely in JGBs for lack of better alternatives (second chart below). To this point, deposits at Japanese banks exceeded the aggregate size of their loan book by ¥173.2 trillion as of JUL; this spread, also known as the “Yotai Gap” is equivalent to 17.4% of the total amount of JGBs outstanding, creating a substantial amount of excess demand.






For additional drivers of JGB  market strength in the face of an overwhelmingly-consensus bearish thesis, refer to our MAR 2 presentation titled, “JAPAN’S DEBT, DEFICIT AND DEMOGRAPHIC RECKONING” as well as in our MAR 30 note titled, “DIGGING DEEPER INTO JAPANESE SOVEREIGN DEBT” and our JUL 27 note titled, “ARE JAPANESE GOVERNMENT BONDS POISED TO MAKE SOME NOISE”. Staying on top of which levers are at the most risk of becoming unsupportive on the margin are the key to staying ahead of a JGB market crisis, should one materialize over the long-term TAIL.


Jumping back to ramifications of Japan’s looming government shutdown, we view point #3 as laid out above as among the key catalysts for a JGB market crisis over the intermediate term. Per our calculations according to Basel II standards, Japanese banks would be on the hook for a $79.1 billion capital call in the event JGBs become a single-A entity (at the current exchange rate), after previously having to hold no capital against these assets. It remains to be seen how Japanese banks plan to react to this event; they could merely slow demand for other assets or they could materially slow their rate of JGB accumulation. Time will certainly be more telling here than we ever could; at any rate, we maintain that this is not a risk that should be glossed over by investors.




In addition to a changing risk profile of Japanese bank exposures, we also view a structural shift in long-term inflation expectations as a key catalyst for a JGB crisis; our latest thoughts here were previously outlined in the latter of the aforementioned research notes. To this point, the amount of JGBs held on the BOJ balance sheet now exceeds the total supply of banknotes in the country (¥80.96 trillion vs. ¥80.78 trillion), raising concern that investors will lose confidence amid fears of runaway inflation perpetuated by sovereign debt monetization – an event which has already happened twice in Japan: during the Great Depression and during WWII.


The BOJ counters that it does not include JGBs bought as part of its “transitory” asset purchase program in its calculus, allowing it to exceed the self-imposed “banknotes rule”. The obvious risk here is that BOJ Governor Masaaki Shirakawa loses credibility with the market; we suspect he knows this and that this has been a contributing factor to the BOJ’s unwillingness to acquiesce to incessant political demands for incremental monetary easing. At the current pace of accumulation (¥3.9 trillion per month in 2012; ¥2.8 trillion per month in 2013), the BOJ will have increased its ownership of JGBS by ¥44 trillion in the current fiscal year – more than the ¥40 trillion to be issued per the aforementioned FY12 deficit financing bill!


All told, we see three ramifications of a potential/actual Japanese government shutdown over the near term: a potential sovereign default, a potential sovereign credit rating downgrade(s) and an associated $75-80 billion capital call across the Japanese banking system in the event JGBs are downgraded to single-A level by Moody’s and/or Standard and Poor’s. Moreover, the confluence of these risks has the potential to perpetuate a meaningful back-up in JGB yields over the intermediate term – though, admittedly, this remains an improbable risk for the time being.


Stay tuned,


Darius Dale

Senior Analyst

Did the US Economy Just “Collapse”? "Worst Personal Spending Since 2009"?

This is a brief note written by Hedgeye U.S. Macro analyst Christian Drake on 4/28 dispelling media reporting that “US GDP collapses to 0.7%, the lowest number in three years with the worst personal spending since 2009.”

read more

7 Tweets Summing Up What You Need to Know About Today's GDP Report

"There's a tremendous opportunity to educate people in our profession on how GDP is stated and projected," Hedgeye CEO Keith McCullough wrote today. Here's everything you need to know about today's GDP report.

read more

Cartoon of the Day: Crash Test Bear

In the past six months, U.S. stock indices are up between +12% and +18%.

read more

GOLD: A Deep Dive on What’s Next with a Top Commodities Strategist

“If you saved in gold over the past 20 to 25 years rather than any currency anywhere in the world, gold has outperformed all these currencies,” says Stefan Wieler, Vice President of Goldmoney in this edition of Real Conversations.

read more

Exact Sciences Up +24% This Week... What's Next? | $EXAS

We remain long Exact Sciences in the Hedgeye Healthcare Position Monitor.

read more

Inside the Atlanta Fed's Flawed GDP Tracker

"The Atlanta Fed’s GDPNowcast model, while useful at amalgamating investor consensus on one singular GDP estimate for any given quarter, is certainly not the end-all-be-all of forecasting U.S. GDP," writes Hedgeye Senior Macro analyst Darius Dale.

read more

Cartoon of the Day: Acrophobia

"Most people who are making a ton of money right now are focused on growth companies seeing accelerations," Hedgeye CEO Keith McCullough wrote in today's Early Look. "That’s what happens in Quad 1."

read more

People's Bank of China Spins China’s Bad-Loan Data

PBoC Deputy Governor Yi says China's non-performing loan problem has “pretty much stabilized." "Yi is spinning. China’s bad-debt problem remains serious," write Benn Steil and Emma Smith, Council on Foreign Relations.

read more

UnderArmour: 'I Am Much More Bearish Than I Was 3 Hours Ago'

“The consumer has a short memory.” Yes, Plank actually said this," writes Hedgeye Retail analyst Brian McGough. "Last time I heard such arrogance was Ron Johnson."

read more

Buffalo Wild Wings: Complacency & Lack of Leadership (by Howard Penney)

"Buffalo Wild Wings has been plagued by complacency and a continued lack of adequate leadership," writes Hedgeye Restaurants analyst Howard Penney.

read more

Todd Jordan on Las Vegas Sands Earnings

"The quarter actually beat lowered expectations. Overall, the mass segment performed well although base mass lagging is a concern," writes Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan on Las Vegas Sands.

read more

An Update on Defense Spending by Lt. Gen Emo Gardner

"Congress' FY17 omnibus appropriation will fully fund the Pentagon's original budget request plus $15B of its $30B supplemental request," writes Hedgeye Potomac Defense Policy analyst Lt. Gen Emerson "Emo" Gardner USMC Ret.

read more