wmeubank@ocp.kcmo.com
WHAT HAS REALLY CHANGED IN JAPAN?
Prepared by Jack McIntyre
Yesterday's price action in JGBs and the yen was more about position adjustments than any new trend unfolding.
JGBs are currently experiencing a “double negative whammy” based on the results of the details of the LDP's fiscal stimulus package for Japan. The first negative influence was PM Hashimoto's support for a 2 trillion yen tax cut for individuals (market had expected only a corporate tax cut). This could provide the Japanese consumer with a confidence boost, but it is only a one-off event (unlike 1994). Moreover, just because the Japanese consumer has extra yen in their pockets does not mean that they will spend it (the country has a high savings rate). The other negative factor and it has longer-term implications, is that the this tax cut is going to be financed by issuing bonds which is going to put supply pressures on JGBs. Either way you look at it, not good for JGBs over the very near term. Particularly, given this market's growing “long bias” which has developed during the second part of the year.
We cannot say with confidence that this latest fiscal stimulus package is the answer to all of Japan's problems. It will help. But its ultimate impact will not be know until well into the 1998 fiscal year. In fact, we suspect that things will continue to get worse before they get better which is why the downside in JGBs may be limited. We really expect that the JGB market will begin to consolidate which is needed in order to see what impact the tax cut will have on the Japanese economy.
For now, we are looking at the price action in $/yen as long liquidation and only corrective. The details of the LDP package caught the FX market leaning one way, long $/yen. If recent history holds this time, weakness in this cross will not last and it has proved to be a better buying opportunity than selling opportunity. This time may not be that different. From a seasonal standpoint, the last half of December has been “yen friendly” over the past 15 years. The fundamentals on both sides of the Pacific support a stronger $/yen (one country's budget deficit is shrinking while the other country's budget deficit is growing) and until we see improvement in the Japanese economy, this will be the case.
In terms of the yen contract, prior to yesterday's rally, there was a record net short position by the large traders according to the latest COT data (they were short 43,148 contracts back on 12/2 so we are sure they have even a larger net short position before yesterday). Much of the buying yesterday was driven by short covering which makes today's session that much more important in terms of deciding whether this up move is sustainable or not.
December 18, 1997MCM, Inc.
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