Unhedged Commentary
Kyle Bass expects radical government intervention in Japan
September 07, 2010
As he bets on the country's decline, Bass writes that the yen and Japanese government bonds are experiencing a short-term squeeze that will result in more intense government-led responses.
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Kyle Bass
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Hayman Advisors founder Kyle Bass (who will keynote the upcoming AR Symposium) wrote to the firm's investors on September 7 with his thoughts about Japan’s continuing economic malaise. The firm is taking concentrated bets on the deterioration of the yen and Japanese government bonds. His thoughts are reproduced here:
Macroeconomic Data
• This month saw the release of the 2nd Quarter GDP numbers for Japan, which showed a marked slowdown in economic growth. The nominal GDP growth rate for the second quarter was -0.9% (lower than estimated) and was a -2.3% change from the previous quarter. Not only does this take the wind out of the sails of those predicting a strong return to growth for the Japanese economy, it actually puts the economy firmly on track for another recession. We believe this is very relevant to JMOF because a rapidly deteriorating economy puts further stress on Japan’s fiscal balance sheet by lowering government revenues and creating strong political pressure for further stimulus.
Yen and Rates Strength
• The month was also characterized by strong appreciation in both the currency and government bond markets in Japan. The 5yr JGB saw its yield decline from 35.8bp to 26.1bp, and there were moves of similar size in other parts of the yield curve. In addition, the yen strengthened from 86.47 to 84.21 (Yen/USD) during the month, including a brief dip below 84. This prompted widespread discussion of an official intervention in the FX market in order to weaken the yen. No such action has been forthcoming; however, we believe the political developments discussed below will have an impact on this timeline.
• We believe that the majority of this move was a response to the decline in US interest rates and equities during the same period, driven by weakness in US macroeconomic data. It is likely that this temporary “flight to quality” will persist until the market pressure and concern is focused primarily on the Japanese economy rather than on the US or Europe.
Political Instability
• The movements in the yen, combined with the worsening economic data have forced a change in policy thinking in Tokyo. PM Naoto Kan has already reversed his commitment to fiscal austerity and pledged a new round of stimulus. There are many in the Japanese parliament, however, who view this as insufficient. Not only has a contender, Ichiro Ozawa, emerged to challenge Kan in the mid September party elections (which will determine who leads the DPJ and thus who will be the PM of Japan), but he has promised an even more aggressive stimulus package as well as a more forceful response to the strength of the Yen.
• Ichiro Ozawa may not be very popular with the general public, but he has a lot of influence within the DPJ and stands a very good chance of beating Kan and becoming Japan’s 6th Prime Minster in the last four years on September 14th. He would also become Japan's 15th PM in the last 20 years (hardly the hallmark of stable government).
• The BoJ also scheduled an emergency meeting to respond to concerns that the yen had appreciated too quickly and to falling government bond yields. Governor Shirakawa flew home early from a summit of central bankers at Jackson Hole in oredr to convene the meeting which resulted in an extenion of an additional 10 trillion Yen ($119 billion USD) of liquidity support to the financial markets. It is our belief that this is a token gesture by the BoJ to take some pressure of them to act more aggressively. We believe the DPJ's public cries to the G7 last week were a plea for coordinated intervention in the Yen. If and when they act unilaterally to weaken the Yen as a public policy, it could well be the straw that ends up breaking the camel's back.
• In addition one of the new parties in the parliament – the ‘Your Party’ – has revealed planned legislation to force the Bank of Japan to target inflation more aggressively through further debt monetization and to target a specific Yen level of 90 or above through intervention in the FX market. We believe that there will be some broad support for this bill because it sets out a clear plan to try and break Japan out of the deflationary cycle, even at the expense of breaching BoJ independence.
In general, we believe that the movement in the Yen and in Japanese rates is a short term squeeze that will actually drive even more radical policy by the government and central bank especially in light of the dramatic slowing of the economy. It is our contention that an embrace of radical policy (i.e. massive FX intervention or large scale monetization) will lead to the unintended consequence of a breakdown in confidence in both the currency and the government bond market. We remain confident of the medium to long term outcome of our investment thesis.
As S&P analyst Takahira Ogawa put it today in comments to the Dow Jones News Service - “Unfortunately, I can’t find any factors that would cause us to improve our Japan rating outlook.”
Related:
Bass to headline 7th annual AR Symposium
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