Abenomics: Market Moves Too Good To Be True

BMI View: The Bank of Japan's bond buying programme, and the positive inflation expectations that it has fostered, have proved to be a major boon for local financial assets, with bond yields remaining extremely low and the Nikkei soaring. We are looking for a way of benefitting from a reversal of the positive financial market moves brought on by these inflationary policies, as we believe they will ultimately be found to expedite a fiscal crisis. We are bearish on a volatility-weighted index of the Nikkei, the 10-year JGB, and JPY/US$, and expect to see some major market moves over the coming months.

From the standpoint of Japan's financial markets 'Abenomics' (or specifically the aspect of it which aims to generate inflation at all costs) has been an overwhelming success. The aims of ramping up government bond buying to force investors into risky assets, generate inflation expectations, and depress government bond yields, have all been achieved. With the exception of a few hiccups, such as the surge in bond yields in May, there has been very little push-back from investors, who have seen only the positive implications of a return to inflation.

The problem with generating inflation in an economy with a government debt burden of almost 250% of GDP is that bond yields will face significant upward pressure eventually. It is possible for the Bank of Japan to suppress these pressures only at the cost of weakening the currency. To compensate investors for the loss of purchasing power on Japanese bonds, the yen must fall by a sufficient amount to set up the expectation of future appreciation in order to offset the shortfall in interest rate returns. This is what we are seeing now. The yen has broken below support and looks like it is heading significantly weaker.

Testing Major Support
Japan - 10-Year JGB Yield, %

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