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JAPAN TO LOOSEN FISCAL POLICY AS WELL

Takeaway: Japan’s fiscal POLICY outlook augurs bearishly for the yen over the intermediate term.

SUMMARY BULLETS:

 

  • Between now and the JAN 22nd BOJ meeting and from then until the APR ’13 replacements of the BOJ governorship and two deputy-governorships, Japan’s fiscal POLICY outlook will take center stage in our TREND/TAIL call for a demonstrably weaker yen.
  • Ahead of the APR 1st fiscal new year, Abe and Aso will craft a “large-scale” supplementary budget for the FY12 year (likely > ¥10 trillion), as well as a FY13 federal budget. Regarding the latter, the previously-imposed ¥71 trillion spending cap for FY13 was recently disregarded by the LDP, suggesting Abe is poised to take public expenditures to new heights. In short, we think Japan’s pending fiscal and monetary POLICY mix risks igniting a backup in JGB yields that could threaten Japan’s fiscal sustainability, potentially triggering a European-style sovereign debt crisis.
  • Regarding the yen specifically, sell-side consensus and Japanese exporters do not yet agree with our call for sustained yen weakness over the intermediate-to-long term. Sell-side consensus expects the currency to strengthen to ¥83 per USD by the end of 1Q13 and Japan’s large manufacturers expect it to average ¥78.73 per USD in the fiscal half year through the end of MAR ’13 (up from the current average of ¥81 in the fiscal-half-year-to-date).
  • To the extent the latter party joins the “party” we could see another meaningful leg down in the yen over the next few months, as commercial traders remain positioned long of the JPY to the tune of two standard deviations relative to the trailing 52-week average.

 

While we were away, Japan’s parliament approved Shinzo Abe as the nation’s seventh prime minster throughout the past six years, returning him to a post he abandoned in 2007. Coming in hot, Abe was quick to name Taro Aso as his minister of finance – Japan’s sixth finance chief throughout the past three years. With political turnover like that, it’s no wonder Japan is struggling mightily to get its fiscal house in order.

 

Aso, a former prime minster in his own right in the 12 months through SEP ’09, will also serve as deputy prime minster and financial services minister in Abe’s cabinet. This give the LDP a strong 1-2 spending punch atop Japanese leadership, as both Abe and Aso are champions of Keynesian-style, countercyclically-expansionary fiscal POLICY.

 

During his brief stint as prime minster, Aso introduced three extra budgets worth about ¥20 TRILLION, abandoned a pledge to balance the budget by March 2012 and distributed a ¥12,000 per-person cash handout. A supporter of the “by any means necessary” fiscal POLICY that has plagued the Japanese sovereign balance sheet for much of the past ~20 years, Aso has developed a reputation for signing off on seemingly wasteful stimulus initiatives (such as authorizing ¥12.4 BILLION in 2009 for the cleanup of fishing gear).

 

It should be noted that Abe, Aso and their underlings will be hard at work on crafting a “large scale” supplementary budget for the FY12 year (ending in MAR ’13), as well as a FY13 budget that takes Japanese public expenditures to new heights. The party has already abandoned the previously-imposed ¥71 trillion spending cap for the upcoming fiscal year (starting in APR ’13); following through with that pledge would grow Japan’s primary public expenditures by roughly +4% YoY in nominal terms.

 

Importantly, doing that in a time of economic calamity as Japan currently is in (second recession in the last two years; third in the last four) would likely impose a greater reliance on sovereign debt issuance to fund public expenditures. We consider it crucial that Japan is poised to surpass the 50% mark with regards to the sovereign’s bond dependency ratio in the upcoming fiscal year – i.e. over half of public expenditures will be funded via debt issuance, as opposed to more traditional revenue sources such as tax and fee collection.

 

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Indeed, historical trends for the growth of sovereign debt service and total tax & fee revenue suggest long-term holders of JGB’s should be very leery of the Abe/Aso duo. Extrapolating CAGRs from the previous five years suggests Japan’s sovereign debt service is poised to completely consume all traditional revenues in 15 years – i.e. the “point of no return” or the sovereign “endgame”, so to speak. There are a myriad of reasons why 15 years is a really aggressive assumption (i.e. the point of intersection is likely much further into the future), but it is a fun theoretical exercise nonetheless.

 

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What is not theoretical is the fact that both Japan’s sovereign debt service (currently 24.3% of total public expenditures) and interest expense (currently 44.7% of total debt service) continue to grow in nominal terms – despite the sovereign’s weighted average cost of capital plunging to new lows in recent years (1-1.2% by our estimates, down from 2% ten years ago and 5.8% twenty years ago).

 

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To the extent Abe makes good on his promise for +3% nominal GROWTH and +2% consumer price INFLATION or if his POLICY mix induces a stagflationary concoction of said “monetary math” (i.e. +1% GROWTH and +4% INFLATION), a demonstrable backup across the JGB yield curve could make the aforementioned theoretical exercise a lot closer to reality than what we think is currently implied by a sovereign CDS quote of 81bps. It should be duly noted that the trailing 10-year averages for Japan’s nominal GDP growth and CPI are -0.7% and -0.2%, respectively.

 

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This is why we continue to express caution regarding Japan’s pending monetary and fiscal POLICY mix – specifically in that a backup in JGB yields could threaten Japan’s fiscal sustainability, potentially triggering a European-style sovereign debt crisis. Fear not, however. Our interpretation of market chatter suggests Abe fundamentally believes Japan can avert a meaningful jump in bond yields a long as the central bank is committed to unlimited financing of the sovereign; per the latest data (3Q12), BOJ holdings of JGBs increased to the highest on record (¥104.9 TRILLION or 11.1% of all sovereign debt).

 

To the extent investors start to anticipate anything meaningfully in the direction of a 1930’s-style debt monetization scheme over the long-term TAIL, it could be “look out below” with respect to the market PRICE of the Japanese yen and the market PRICE(s) of Japanese sovereign debt. We wouldn’t want to be holding the bag on Japanese equities in that scenario, which is exactly why we continue to anticipate reflation in the months ahead, but refuse to endorse the trade explicitly.

 

On the monetary POLICY front, the latest developments suggest that the LDP will consider revising the BOJ’s mandate if the board fails to double its INFLATION target at the JAN ’13 meeting. Abe also suggested that he plans to nominate a BOJ governor that favors the policies of his party and explicitly stated that it was vital for Japan to resist the strengthening of the yen which he sees as a likely result of other countries weakening their currencies.

 

Be careful what you wish for Misters Abe and Aso; you just might receive it. On that note, the JPY has fallen for six consecutive weeks vs. the USD as is now at multi-year lows of ~¥85.61 per USD. In the spirit of keeping score, Japan’s currency has plunged -9.4% vs. the USD since we outlined our TREND-duration bearish thesis on 9/27; that compares to regional median gain of +0.2%.

 

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From a sentiment perspective, sell-side consensus and Japanese exporters do not yet agree with our call for sustained yen weakness over the intermediate-to-long term. Sell-side consensus expects the currency to strengthen to ¥83 per USD by the end of 1Q13 and Japan’s large manufacturers expect it to average ¥78.73 per USD in the fiscal half year through the end of MAR ’13 (up from the current average of ¥81 in the fiscal-half-year-to-date). To the extent the latter party joins the “party” we could see another meaningful leg down in the yen over the next few months, as commercial traders remain positioned long of the JPY to the tune of two standard deviations relative to the trailing 52-week average.

 

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Lastly, to review the POLICY and PRICE catalysts embedded in our bearish thesis on the Japanese yen, we view each one of the following risks as probable over the next 12-18 months:

 

  • A +2-3% joint Diet-BOJ INFLATION target (JAN ’13?);
  • A meaningful expansion of public expenditures and “large scale” stimulus package (1Q13?);
  • A VAT hike delay (2H13?);
  • The LDP wins a  majority in the Upper House pending elections (JUL or AUG?);
  • An erosion of BOJ independence, with the BOJ governorship and two deputy governorships eventually assumed by LDP puppets (1H13?);
  • Experimental monetary POLICY – particularly a foreign asset purchase program (1H13?); and
  • The UST 2Y-JGB 2Y yield spread widens in any meaningful way (2013?).

 

Stay tuned; if the market is telling us anything, it’s that this train is just getting started.

 

Darius Dale

Senior Analyst


Destroying The Yen

The Bank of Japan recently decided it would prefer to follow in the footsteps of the United States and the Federal Reserve. Japan's policy of debauching its currency, the yen, is part of a plan to stop its strength. As you can see in the chart below, the yen has fallen considerably over the last three months and recently hit a 27-month low against the US dollar. Japan thinks that more stimulus spending, currency printing and bailouts are the surefire way to fix the Japanese economy; if the US economy is anything to go by, that type of plan is but nothing but wishful thinking.

 

Destroying The Yen - YEN


Goodbye Gold

The great commodity super-cycle is in the process of turning and driving commodity prices down with it. As the American economy moves from "Growth Slowing" to "Growth Stabilizing," the artificial commodity bubble  brought on by the policies of the Federal Reserve is now popping. Plenty of investors, from hedge funds to individuals, are long gold and it's beginning to really hurt. Gold snapped our long-term TAIL risk line of $1671 last week, which means the price is likely to continue falling until catching some kind of support. Gold is down nearly $100 over the last month alone and CFTC gold net long contracts are down -13% week-over-week as investors flee. This is what happens when you let Ben Bernanke take control of the wheel.

 

Goodbye Gold - annotategold


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Moshe Silver: Money, Riches & Wealth

 

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Recovery In The Housing Market

Recovery In The Housing Market - SA YoY

 

 

Five years after the financial crisis, investors are welcoming recovery in the housing market. Several data points that have come out over the last six weeks or so indicate that housing is doing well with inventory falling, home prices rising and mortgage applications increasing. This morning's S&P/Case-Shiller data shows that October home prices increased 4.3% year-over-year, beating expectations of 4.0%. That's the best improvement since May of 2010.

 

We've highlighted some data points over last two weeks from the housing sector:

 

* HOUSEHOLD FORMATION REMAINS STRONG IN NOVEMBER (note 12/20)

* Inventory of existing homes for sale sank 3.8% month-over-month to 2.03 million units, down from 2.14 million units in October. (note 12/20)

* The rate of existing home sales in November was stronger than expected at 5.04 million (SAAR) vs. consensus expectations for 4.9 million and was up 5.9% month-over-month vs. October. (note 12/20)

* Builder confidence rose further in December, as this morning's NAHB HMI reading was 47, up 2 points MoM from a revised composite reading of 45 in November. (note 12/18)

* The MBA Mortgage Purchase Applications Index rose 1.0% last week. This is the fifth consecutive week of positive WoW growth. (note 12/12)

 

Hedgeye Financials Sector Head Josh Steiner breaks down this morning's Case-Shiller data in detail:

 

"Looking at the data on a city-by-city basis, Phoenix and Las Vegas showed the strongest month-over-month improvement, rising 1.4% and 2.8%, respectively. Meanwhile, Boston and Chicago were the laggards. On a year-over-year basis, Phoenix is blowing the rest of the country away, up +21.7% YoY, followed by Detroit +10.0% YoY. Clearly the distressed market has turned from headwind to tailwind. The weakest two markets nationally on a YoY basis are New York and Chicago, both down just over 1%.

It's also worth noting that New York has an enormous weighting in Case-Shiller. New York accounts for 19.4% of the index. Considering NYC is the worst performing market in the country, and accounts for one-fifth of the index, it's a testament to how strong the real estate market throughout the rest of the country is." 

 

 

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HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON

Takeaway: More evidence of home prices accelerating, while the government is poised to add further stimulus to an already strengthening recovery.

Home Price Data Reinforces Main Street Confidence

This morning's Case-Shiller HPI reading for October showed further acceleration. On a year-over-year basis, home prices rose by 4.3% in October, up from a 3.0% YoY increase in September. This should come as no surprise as Case-Shiller reflects Corelogic data on a lag, as it is a 3-month rolling average. Nevertheless, the market, media and Main Street continue to ascribe greater significance to this series, which makes it important.

 

Once of the central tenets of our bullish housing call is that good news in housing feeds on itself. As Main Street hears more and more good news about housing's recovery, that begets greater demand as demand is positively correlated with price. That rising demand, in turn, fuels ongoing price increases in a virtuous loop.

 

In our recent Black Book "Housing Heading Higher in 2013" we laid out the bull case for housing's recovery being stronger than expected in 2013. This morning's print is another data point in support of our thesis. 

 

Looking at the data on a city-by-city basis, Phoenix and Las Vegas showed the strongest month-over-month improvement, rising 1.4% and 2.8%, respectively. Meanwhile, Boston and Chicago were the laggards. On a year-over-year basis, Phoenix is blowing the rest of the country away, up +21.7% YoY, followed by Detroit +10.0% YoY. Clearly the distressed market has turned from headwind to tailwind. The weakest two markets nationally on a YoY basis are New York and Chicago, both down just over 1%.

 

It's also worth noting that New York has an enormous weighting in Case-Shiller. New York accounts for 19.4% of the index. Considering NYC is the worst performing market in the country, and accounts for one-fifth of the index, it's a testament to how strong the real estate market throughout the rest of the country is.

 

Further Government Involvement Is a Positive for Housing

Normally, weekly mortgage application volume data is released on Wednesday morning, but in light of the holiday it seems to be on a delay. We will provide an update once the data hits. That said, we wanted to flag an article in the Wall Street Journal as an interesting read.

 

The article describes new initiatives by the Obama administration to expand the refinancing programs backed by the government. The idea is to allow non-GSE loans that are underwater to be refinanced, though it's unclear how this would be achieved. One proposal has these loans being transferred to Fannie and Freddie, but there doesn't appear to be any consensus around whether this would also entail putback immunity for the banks underwriting the refi. This would be a major undertaking, however, as it would require a change to Fannie and Freddie's charters, which can only be done by Congress. Another proposal would allow non-GSE borrowers to refinance underwater loans through HAMP. This would be the path of least resistance as it would require no involvement by Congress. Currently, HAMP only allows underwater refis for borrowers at imminent risk of default. The proposal would modify those guidelines to include underwater borrowers not at risk of default.

 

While it remains to be seen what, if anything will come of this, it seems clear that the two scenarios here are either status quo or further stimulus for housing. As such, the expected outcome is another positive for housing. Our Black Book had flagged further government initiatives as an ongoing catalyst to the strengthening recovery in housing and this article appears to support that conclusion. Here is the link to the article WSJ.

 

HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON - SA YoY

 

HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON - NSA YoY

 

HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON - YoY

 

HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON - MoM

 

HOUSING: ACCELERATING PRICE GAINS AND MORE STIMULUS ON THE HORIZON - NSA MoM

 

Joshua Steiner, CFA

 

Robert Belsky


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