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16 April 2013
16 APRIL 2013
Kevin Gaynor
+44 20 7102 7800 kevin.gaynor@nomura.com
Muhammad Kirdar
+44 20 7103 0091 Muhammad.Kirdar@nomura.com This report can be accessed electronically via: www.nomura.com/research or on Bloomberg (NOMR)
Overarching considerations
Some things are immediately apparent from even a cursory reading of our Japanese team's research: 1. This is a persistent topic, and it will take some time to play out. The BOJ's actions are only one component of the whole policy picture, around which some uncertainty remains. However, the run-up to the Upper House election and the supply-side reform agenda are to take centre stage domestically. 2. We are now in a period of learning, perhaps even at the BOJ itself with regards to how the new BOJ policy will be conducted operationally. What
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this means for real and nominal yields, and therefore the impetus to reallocate out of JGBs, is still an open question. 3. As such the impact on global markets is contingent on domestic government yields, FX hedging costs and foreign return opportunities, and of course whether the policy actually works. Obviously, the BOJ itself has an influence on how it flexibly conducts its operations and indeed could add further balance sheet tools if required. Set against that is the role of other countries which may have tolerated the JPY move thus far but may react from here. 4. There are several interacting dimensions as to how this may play out for markets but we see the most important as: (1) the regional and global economic demand impact of (2) net flows and return expectations of various market participants, each of which have different risk tolerances, regulatory pressures and response times, and (3) changes in asset allocation that result from shifts in the global real discount rate. 5. A key message from this note is that the direct translation of BOJ action into expectations of major sustained Japanese outflows is probably too simplistic. Instead, there is now a Kuroda put, a new high potential energy balance sheet in play where the dynamic of Japanese flow are new spread and FX trigger levels will need to be taken into account in the most directly affected markets which we currently believe are AUD/JPY, MXN and PLN and USTs and US MBS. France and other semi-core countries along with global IG are also, on an FX-hedged carry basis, attractive at the right spread level. Given all of this, the topic is one that we will have to continually monitor and discuss. We have some overarching conclusions, however, even if we cannot offer a golden bullet list of trades.
Outstanding balance of long-term JGBs is to be increased by 50trn a year (more or less doubling gross average monthly purchases to just over 7trn). JGBs of all maturities including 40-year instruments will become eligible for purchase. The average remaining maturity on BOJ purchases will be raised from almost three years to around seven years.
3) ETF and REIT purchases are to be increased (with the following targets)
4) Purchase of CP and corporate bonds is to continue until outstanding balances reach 2.2trn and 3.2trn, respectively (by end-2013), after which outstanding balances will be maintained at those levels.
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5) The asset purchase programme is to be ended and the banknote rule to be temporarily suspended: The asset purchase programme and rinban operations will effectively be combined. 6) Fund-supplying support for financial institutions in quake-affected areas will be extended by one year. See BOJ policy board meeting Qualitative and quantitative easing announced (4 April 2013)
The home bias of domestic JGB holders. The size of the programme is smaller than the Fed's ongoing QE ($700bn vs $1.02 per year). The purchases at the >10yr sector (relevant for lifers and pension funds) are smaller than the Fed or BoE's QE both in absolute terms and relative to issuance in the sector. Notwithstanding these considerations, they think it likely that net outflows will occur but perhaps, all else equal, not at the pace that some commentators and market participants are expecting.
See: Global FX Insights: Where will Kurodas Money Go? (8 April 2013)
Economics
Tomo Kinoshita (Chief Economist Japan) and his team increased their growth and inflation forecasts for fiscal and calendar years 2013 and 2014. They now expect the economy to expand at 2.4% for FY 2013 and 1.4% for FY 2014. These are both above-trend rates of expansion, and FY 2013 is projected to be the highest growth rate since FY 1996 (excluding the 2010 rebound). One key aspect is that domestic demand is expected to take over from Asian demand as the key driver of expansion. While headline inflation and the GDP deflator are set to hit 2%, accounting for the consumption tax hike leaves underlying inflation below 1%. See: Japan: FY12-14 economic outlook revisions: Aggressive BOJ monetary policy likely to boost real economy (12 April 2013)
JGB strategy
Naka Matsuzawa (Chief Japan Rates Strategist) believes JGBs are moving back to a range-bound market. He thinks a sustained JGB sell-off is unlikely unless there is a prevailing view that: (1) the BOJ is done with easing in the current cycle; and (2) the global monetary easing phase has ended. He thinks the first condition has been met, but does not expect the second to take place until the Fed moves closer to ending QE3, probably in JulySeptember. In the near term, he thinks the JGB will find a new equilibrium point after a few rounds of BOJ purchase operations and JGB auctions, and trade within the new ranges. In this environment, he provisionally estimates that the equilibrium points will be near 0.45% and 1.10% for 10s and 20s, respectively, with the lows on 5 April (10s at 0.315% and 20s at 0.845%) likely serving as the lower ends of their respective trading ranges. Lacking support from further BOJ easing,
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which previously had been the primary driver of JGB rallies, the market could react to relatively minor factors, bullish and bearish. Accordingly, he recommends shifting focus from long trades on bull flattening in the superlong zone and look for opportunities to dip-buy cash bonds in tenors that offer relatively high carry and roll, which he thinks should perform better in a range-bound environment. See: Japan Navigator (No. 514) (8 April 2013)
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metrics. Taken together they feel this suggests the belly of the US curve is most attractive and the long end steepening as a result. They also note that life insurance companies in Japan are running foreign asset positions at around 25% of total assets versus a cap of 30% and calculate the difference equates to around USD90bn about the same amount that our Japanese strategy team thinks lifers need to buy in longdated JGBs. As lifers appear to run shorter duration risk in their overseas portfolios than at home, the team judges the belly of the US curve is the sweet spot. The team estimates in the region of USD80-USD110bn of total flow per year. See US rates: Global Rates Insights: BoJ QE-driven Spill-Over into USTs (10 April 2013) Ohmsatya Ravi and the MBS team perform a similar analysis for the MBS market, concluding that, all else equal, the BOJ's announcement adds USD45-53bn to annual net demand for agency MBS for a total flow from Japan of USD61-69bn. They expect most of the net demand to be directed towards GNMA MBS and lower coupon GNMAs (GN 2.5s-3.5s). Given likely issuance of USD 100bn this year, the Japanese and Fed demand should overwhelm supply. Our Japan and global FX strategy teams concur, pointing out that the GNMA MBS FX-hedged yield spread to 20yr JGBs is high relative to recent history. They think this sector is likely to be one of the key beneficiaries of the portfolio rebalancing by Japanese investors. See US MBS: Impact of BOJ Announcement on Demand for Agency MBS (10 April 2013) and Global FX Insights: Where will Kurodas Money Go? (8 April 2013)
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segment of the curve. They would not expect major flows in the UK on the back of the BOJ actions. It has been three years since Japanese investors bought Gilts in any meaningful way, and when viewed through a Japanese lens, FX-hedged UK yields are flat to Germany. No bid is likely come from that kind of valuation. See: European Rates Insights: Time to take stock on EGB moves (9 April 2013) They add that Europe still lacks a large-scale buyer of last resort to help replace the large number of investors who have exited the government bond market. If the European crisis remains non-systemic, the flows resulting from the BOJ action may be sufficient to mask the increasing credit differentiation across European sovereign markets. However, there may come a point where an assigned buyer of risk may be required if European conditions deteriorate further. As such they would avoid buying longer-dated Italy or Spanish debt given the rich valuations and favour a more defensive portfolio. See: European Rates Strategy: Trade Portfolio (12 April 2013)
EM strategy
Tony Volpon and George Lei estimate that the changes in monetary policy in Japan will lead to an increase of retail toshin inflows that may reach USD10bn this year, helping to boost BRL. They also believe that the indirect effect through lower global yields will likely lower rates in Brazil, though recent market movements may have already fairly priced in this impact. See: EM FX Insights: Brazil: Mr. Kuroda and BRL (11 April 2013) More generally the FX team notes that most developed markets bonds look rich relative to their history (aside from France) on a JPY FX-hedged basis. Thus, the search for carry is likely to push Japanese institutional and retail investors into emerging market bonds to a greater degree. They think investment into EM currencies by Japanese institutional investors will likely
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have even lower hedge ratios than for AUD, and will thus be concentrated in large and liquid markets covered by sovereign bond indices for example the Citigroup World Government Bond Index includes Malaysia, Mexico, Poland, Singapore and South Africa. Additionally, since this flow involves even lower FX hedge ratios, it has potential to be more important for FX markets in these countries. Based on past trends, and the size and liquidity of markets, they think the largest destinations of institutional funds are Mexico and Poland. In particular, they think MXN is a likely destination for a large portion of the EM flows, also due to improving growth and a better political backdrop. See: Global FX Insights: Where will Kurodas Money Go? (8 April 2013)
Olgay Buyukkayali, Peter Attard Montalto and James Burton note that, within EEMEA, the biggest beneficiary should be TRY for retail flows and PLN for institutional flows. As per South Africa, Japanese investors have recently started to focus elsewhere, such as Turkey and Mexico. They judge that trend will probably prevail for now. Hence, for EEMEA, they expect Poland to capture most of institutional inflows bolstered by strong fundamentals, better growth and fiscal than core Europe, similar volatility and higher yields than core Europe. Similarly, Turkey, for which they expect multi-upgrades, should be a target for retail investors and for some institutional investors. They recommend owning long-end bonds in Turkey and Poland. There is also another market Japanese investors are starting to look at Russia. It has not been a traditional uridashi market, but it has one of the highest yields in EM these days and reasonably strong growth/balance sheet dynamics. They do not expect flows to be comparable to those in BRL, MXN or TRY at this stage, but think there will probably be inflows which can potentially benefit 2-5 years of rate curves and to some extent the currency. They continue to recommend receiving 2yr RUB swaps. See: ZAR: Japanese investors focused elsewhere, for now (15 March 2013), Which one would you buy: Polgbs or Bunds? (15 February 2013), If the economy is not hot, time to buy TURKGB 8.5% Sep 22) (28 February 2013) and Adding to RUB 2y cross currency swaps (11 April 2013)
Equity strategy
Hiromichi Tamura, Hisao Matsuura and Jun Yunoki have revised their domestic equity index return forecast for end-2013 targets for the Nikkei Average from 14,500, to 16,000, and for the TOPIX from 1,200, to 1,350 as they view the BOJs monetary easing in a different dimension is at a level that investors had not anticipated. Our mainstream Japanese equities investment strategy is to focus on sectors that stand to benefit from reflationary policies and Abenomics, such as real estate/financials for the former and retail/machinery for the latter. See: Japanese equities investment strategy (12 April 2013)
Ken Takamiya takes a positive view of the quantitative and qualitative easing (QQE) announced by the Bank of Japan on 4 April in terms of how he expects it to affect the valuations of major Japanese banks and their BPS (by increasing unrealised gains on equity holdings). They present their views on the likely shape of investment activity by banks following the introduction of QQE. The two conclusions drawn are: (1) deposits at the BOJ look likely to increase; and (2) investment in foreign bonds using foreign currency is likely to rise but probably along the trend line seen to date. See Major banks securities investments (16 April 2013)
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Michael Kurtz notes that, in the ex-Japan equity space, the implications of aggressive Japanese reflation can be segregated into flow-driven and fundamental effects. He upgraded Japan to an Overweight in the global context on 3 December (2012), a change funded out of Europe by reducing his previous Overweight UK equity recommendation to Neutral. Indeed, benchmarked global funds themselves seem to have arrived at similar allocation decisions, as survey-based data from EPFR show global funds having increased Japan (and US) exposure since late-2012 largely at the expense of Developed Europe. Within the Asia-Pacific region, increased Japan positions appear largely to have been funded via reduction of China and/or Korea exposure the latter largely reflecting concerns over zero-sum competitiveness losses driven by yen depreciation relative to the won and the substantial degree of competitive overlap between the two economies. In terms of the potential for Japanese cross-border flows in an environment of expanding yen liquidity, Kurtz notes that the story for now appears mostly a fixed-income phenomenon. Even considering the relative rise of other currencies vs. the (falling) yen, the combined [equity + currency] returns in Asia ex-Japan, for example, have failed to match Japan-local equity returns (underperforming by roughly 12% YTD). Indeed, Japanese Finance Ministry data show December-February domestic Japanese equity net-repatriation suggesting Japanese equity investors, at least, have been more enticed home by the reflation of domestic ROEs than put off by the yen's sliding value. Admittedly, March data for Japanese overseas toshin investment funds show a switch to a small net-outflow to foreign equities, but at 60bn (or US$630mn) the amount is negligible. Moreover, he notes that toshin equity exposure is essentially too small to be consequential in any market where they are active. Toshins' largest exposure as a percentage of local market-cap in any single market is in Vietnam (still at just 0.37%). However, for yield-seeking Japan outflows, in the equities space, AsiaPacific REITs do offer a logical incremental step out the risk curve from highquality, liquid fixed-income yield and thus may receive substantial flows. The key Asia-Pacific REIT markets are: Australia (accounting for 53% of regional market-cap in the space); Singapore (25%); and Hong Kong (13%). Fundamental equity impacts flow primarily from currency effects, as many regional firms (notably Taiwanese) still have substantial Japan-sourced component costs, allowing them to benefit from cheaper inputs. Similarly, Japanese JV operations listed in China, India and elsewhere derive cost benefits from cheaper Japanese-sourced parts. By contrast, German and Korean stocks seem the closest to zero-sum victims of yen depreciation, but even for Korea, Kurtz notes that expanding export demand historically has been more decisive a determinant of KOSPI performance than the won-yen or won-dollar exchange rate. For example, despite the almost continuous 33% appreciation of the won vs. the yen during 2004-07, the KOSPI considerably outperformed both the MSCI Asia-Pac ex-Japan benchmark in US$ terms (by more than 27% cumulative) and the Nikkei. Moreover, the policy stance in Seoul appears to have shifted in recent weeks, and Korean officials are now responding to JPY depreciation with KRW depreciation of their own, suggesting far less incremental FX competitive loss for Korean exporters going forward in any case. Lastly, still underappreciated, he believes, are the potential benefits for Asia ex-Japan equity markets from the reflation of Japanese domestic demand. Not only could the world's third-largest economy finally doing the right thing after two decades of monetary policy error arguably remove a key background risk from equity markets, but Japan stands as a key potential new incremental source of final demand as a driver of corporate top-line
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earnings. Of note, for example, YTD our economists have upgraded their Japanese nominal GDP forecast for full-year 2013 by an incremental US$66bn more than offsetting the US$49bn incremental downgrade in our Chinese 2013 nominal GDP forecast since then. See: Global Equity Strategy Monthly - Pushback Mountain (6 February 2013)
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ANALYST CERTIFICATIONS
We, Kevin Gaynor and Muhammad Kirdar, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.
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