The hunt for yield is in full force, but this time it’s a question of where Japan is going to invest. The BoJ’s actions seem to have gone so far above and beyond expectations that corporate Japan is looking at risk assets in a whole new light.
Yesterday’s ¥1.2 trillion JGB (Japanese government bond) auction got away without issue, being twice over subscribed, and the question is now with domestic yields so low, is it not worth re-allocating a portion of their overall portfolio towards higher yielding assets? Whether the best destination is the US, where the ten-year treasury commands a 122bp (basis point) premium to the same maturity Japanese bond, or Australia where its government bonds yield is 267bp over JGB’s yield, or domestic bank deposit rates which can still achieve over 4%, is debatable. You can also look in Europe where Italian and Spanish bonds still yield over 4%, although obviously carry a larger degree of sovereign risk than Australia.
JGBs are clearly not going to move materially higher, despite corporate Japanese selling given the BoJ will be buying in such size, and of course there will be other money managers who want to align themselves with that policy(do as a central bank does etc.). However, when the BoJ is buying just under $80 billion of assets a month (given this is modestly under what the Fed is undertaking at $85 billion) in an economy that is half the size, you have to think this commands even more respect right now. The bank wants to see traders continue to push up equities and even buy foreign paper, thus causing even greater JPY outflows. It’s this perception of future JPY weakness that will subsequently see Japanese corporates close USD/JPY and EUR/JPY hedges. Talk on the floors today was that corporate Japan needs to buy $1 trillion to bring hedge ratios to ‘normal levels’, although this seems very high to us. Of course a dramatic move to close out hedge ratios by corporates would give the trade a second wind. EUR/JPY, AUD/JPY and even USD/JPY have to trade higher over time in our opinion.
Today’s Chinese CPI print came in below expectations at 2.1%, and had a strong drop from the prior month. Whether this eases pressure on the PBOC to tighten is debatable, given its immediate focus is on the flow of credit (much of which stems from the shadow banking sector) and a rampant housing market. However, today’s numbers will certainly be welcome news and part of the reason why AUD/USD rallied to 1.0448 and is pushing the Chinese market higher by 0.2%. It is quite feasible to think the PBOC could slow the pace of CNY appreciation on the back of these numbers, although it is base-case that USD/CNY continues to weaken this year.
AUD/USD is at a very interesting point, and while USD/JPY is the main game in town right now, AUD/USD needs to break the recent double-top at 1.0500 (as shown on the chart) to really get a wriggle on. Our preference is to wait for a daily close above here to put on fresh longs and would feel more confident as it moves away from the cluster of moving averages, with the 21-, 55-, 100- and 200-day averages trading in a range of 1.0413 to 1.0358. It’s worth highlighting today’s NAB confidence numbers also came out better than expected.
In the equities space, the Australian market putting on an impressive 1.5% and while financials saw solid gains, it was the unloved materials names that saw traders reverse short positions with some monster moves in the space. Perhaps the market is seeing the $165 billion a month of Fed/BoJ liquidity as a signal to get back in; perhaps it was the valuations, or even the Chinese CPI number gave them the extra confidence after a good open. However, this is the sector to watch now and if we are going to see a short-term rally anywhere in the Aussie market, this looks like it could be the space.
We also heard from the Fed Chairman in early Asian trade, and while most of his comments focused on the US bank stress test, we thought it was positive when he mentioned that expansionary policy among developed central banks was ‘mutually re-enforcing’. Perhaps it was these comments that pushed EUR/USD to 1.3068, although we also feel it was stop loss related, after the pair pushed through the post-Cyprus high of 1.3050. While the pair has pulled back a settlement above here today would be positive for EUR/USD and would see 1.3115 (the 38.2% retracement of the February to March sell-off) come into play.
With earnings season in the US really waiting for JP Morgan, Citigroup and Wells Fargo later in the week, the focus now turns to the UK where we get reads on industrial and manufacturing production. We also get the latest trade and current account from Germany, while in the US the market will get further narrative from Fed members Jeffery Lacker and Dennis Lockhart.