Japan Is Dumping A Record Amount Of Foreign Bonds: Here Are The Implications

Back in February, around the time Bloomberg caught up to what we had been discussing for the past year, namely the historic dumping of US Treasurys by offshore official investors (such as central banks and reserve managers, just as the selling had in fact reversed and foreigners had resumed buying once more) we noticed that it was not China but Japan that had emerged as one of the most aggressive sellers of Treasuries following material Mark-to-Market losses on existing TSY holdings, prompting the foremost ex-Fed shadow banking expert Zoltan Poszar to declare the selling "a deer in the headlights moment".

Fast forward two months, when according to the latest update from Deutsche Bank, Japan's revulsion to fixed income products has accelerateed, and the Pacific island was a net seller of foreign bonds again in the past week, divesting another $12bn worth of securities. It was not only the third straight week of selling out of Japan, according to MOF data, but more remarkably, the the year-to-date divestment of $66bn in foreign bonds YTD is the biggest since 2002, the first full year of such data is available.

What is prompting the sudden liquidation? According to Deustche, "profit-taking most likely explains Japan’s selling."

Ten-year Treasury yields declined in April to a lower level than any previous month since the Trump election. In the process, yen cross-currency basis has tightened to levels not seen since January 2016. Japanese investors use the yen basis (or more precisely, their derivative FX forwards) to hedge the currency risk of their coupon flows from non-yen bonds. The basis tightens when there is a drop in demand to swap yen for dollar.

The next chart, which shows the distinctive inverse relationship between cumulative Japanese purchases of foreign bonds and the 3m yen basis, should be useful to anyone still confused by what has been the biggest driver behind the gradual drop and sudden recent spike in the USD-JPY currency basis: it all has to do with Japanese TSY demand, and hedging costs (which we pointed out had risen so high last August it made TSYs and JGBs look equally priced to Japanese investors).

However, it's not just the Yen basis (and thus relative USD shortage) that is impacted by the Japanese appetite (or lack thereof) for US paper. As the Deutsche fixed income team writes, the lack of love shown by Japanese investors for Treasuries might also be responsible for low 3m Libor fixings and the collapse in Libor/FF spreads.

The details:

In US money markets where Japanese banks also raise dollars, the rates they’ve been paying on commercial paper and certificates of deposit have narrowed vis-a-vis the rates they pay on repos. CP and CD rates are of course used by banks as the main input for daily Libor submissions. Three of the 17 contributing banks to USD Libor are also Japanese. The narrowing of rates Japanese banks pay to borrow dollar using CP/CDs versus repos is further evidence that unsecured funding costs have dropped, which is reflected in the tightening in Libor-FF spreads.

That said, the recent revulsion toward fixed income products out of Japan will probably not last for two reasons.

First, as DB notes, April typically tends to be a month when Japanese investors sell foreign assets as they take profits at the start of the fiscal year. Seasonality would suggest that Japan becomes a buyer again in May, with especially strong appetite for foreign bonds in the July to September period. Consequently, we would look for Libor-FF spreads to find some support in the coming month, especially if Treasury yields become attractive again.

The second reason comes from BofA.

In a recent report, the bank's FX and rates strategists published a piece summarizing the investment plans of nine Japanese life insurance companies for the first half of their fiscal year (which began April 1st). This is what BofA found:

Over the past few years in particular, insurers have been amassing foreign bonds, and particularly US Treasuries, but that fund flow will probably change if US rate hikes continue. Foreign bond investment is increasingly dependent on yields, FX, and FX hedge costs, and will probably become more fluid. In the United States, rate hikes are expected to continue, so the USD/JPY hedge cost cannot be expected to decline much. As par the plans announced, many will likely be less active in hedging foreign bond than last year. Investment in unhedged foreign bonds is expected to be heavily dependent on levels of FX relative to assumptions (see below), and it is more likely to increase. Domestic yields have sunk due to the BoJ’s negative interest rate policy, making fund management in JGBs difficult and prompting the major insurers to stop selling a number of yen-denominated life insurance products.

In other words, the story remains largely the same in that domestic yields are too low for buying JGBs, and life insurers remain without any other option but to buy foreign bonds (Figure 1). However in a key change foreign bond purchases are likely to take place increasingly on a currency unhedged basis (Figure 2), which has two major implications for both Treasurys and US corporate bonds.

First it reduces the need to reach for yield, which means less buying of BBBs and BBs and longer maturities; however it also means that Treasurys across the curve are suddenly far more attractive to Japanese buyers as investors will no longer need to offset up to 80 bps in hedging costs.

Second Japanese life insurance buying is likely to be less steady and more tactical, depending on interest rates and FX. This means more (less) buying when rates vol is low (high). The FX assumption is that the USD/JPY is in the range 100-125 and will increase toward fiscal year end. That means currently at 111 we are in the middle of the range, but since the dollar is expected to appreciate buying will take place here and increase should the dollar weaken, decrease should it strengthen.

This dynamic, together with recent technicals (recall earlier we showed that Treasury futures traders had just experienced the biggest short squeeze in history), mean that the reflation trade could be further jeopardized due to yet another feedback loop linking a weaker dollar (and thus USDJPY), with lower yields, which in turn leads to even more weakness in the USD, and so n. Ultimately, it will be up to the Fed to break this latest adverse feedback loop, although with the US economy growing at just 0.7% in Q1, it will take a significant leap of faith by Yellen and the "data dependent" Fed that US output will recover by Q2 when the Fed is expected to hike by another 25 bps.

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The Inconvenient Truth About Electric Vehicles

Submitted by Gary Novak via Science Errors blog,

An electric auto will convert 5-10% of the energy in natural gas into motion. A normal vehicle will convert 20-30% of the energy in gasoline into motion. That's 3 or 4 times more energy recovered with an internal combustion vehicle than an electric vehicle.

Electricity is a specialty product. It's not appropriate for transportation. It looks cheap at this time, but that's because it was designed for toasters, not transportation. Increase the amount of wiring and infrastructure by a factor of a thousand, and it's not cheap.

Electricity does not scale up properly to the transportation level due to its miniscule nature. Sure, a whole lot can be used for something, but at extraordinary expense and materials.

Using electricity as an energy source requires two energy transformation steps, while using petroleum requires only one. With electricity, the original energy, usually chemical energy, must be transformed into electrical energy; and then the electrical energy is transformed into the kinetic energy of motion. With an internal combustion engine, the only transformation step is the conversion of chemical energy to kinetic energy in the combustion chamber.

The difference matters, because there is a lot of energy lost every time it is transformed or used. Electrical energy is harder to handle and loses more in handling.

The use of electrical energy requires it to move into and out of the space medium (aether) through induction. Induction through the aether medium should be referred to as another form of energy, but physicists sandwich it into the category of electrical energy. Going into and out of the aether through induction loses a lot of energy.

Another problem with electricity is that it loses energy to heat production due to resistance in the wires. A short transmission line will have 20% loss built in, and a long line will have 50% loss built in. These losses are designed in, because reducing the loss by half would require twice as much metal in the wires. Wires have to be optimized for diameter and strength, which means doubling the metal would be doubling the number of transmission lines.

High voltage transformers can get 90% efficiency with expensive designs, but household level voltages get 50% efficiency. Electric motors can get up to 60% efficiency, but only at optimum rpms and load. For autos, they average 25% efficiency. Gasoline engines get 25% efficiency with old-style carburetors and 30% with fuel injection, though additional loses can occur.

Applying this brilliant engineering to the problem yields this result: A natural gas electric generating turbine gets 40% efficiency. A high voltage transformer gets 90% efficiency. A household level transformer gets 50% efficiency. A short transmission line gets 20% loss, which is 80% efficiency. The total is 40% x 90% x 50% x 80% = 14.4% of the energy recovered before the electrical system does something similar to the gasoline engine in the vehicle. Some say the electricity performs a little better in the vehicle, but it's not much.

Electricity appears to be easy to handle sending it through wires. But it is the small scale that makes it look cheap. Scaling it up takes a pound of metal for so many electron-miles. Twice as much distance means twice as much metal. Twice as many amps means twice as much metal. Converting the transportation system into an electrical based system would require scaling up the amount of metal and electrical infrastructure by factors of hundreds or thousands. Where are all those lines going to go? They destroy environments. Where is that much natural gas going to come from for the electrical generators? There is very little natural gas in existence when using it for a large scale purpose. Natural gas has to be used with solar and wind energy, because only it can be turned on and off easily for backup.

One of the overwhelming facts about electric transportation is the chicken and egg phenomenon. Supposedly, a lot of electric vehicles will create an incentive to create a lot of expensive infrastructure. There are a lot of reasons why none of the goals can be met for such an infrastructure. The basic problem is that electricity will never be appropriate for such demanding use as general transportation, which means there will never be enough chickens or eggs to balance the demand. It's like trying to improve a backpack to such an extent that it will replace a pickup truck. The limitations of muscle metabolism are like the limitations of electrical energy.

Electrons are not a space-saving form of energy. Electrons have to be surrounded by large amounts of metal. It means electric motors get heavy and large. When cruising around town, the problems are not so noticeable. But the challenges of ruggedness are met far easier with internal combustion engines. Engineers say it is nice to get rid of the drive train with electric vehicles. But in doing so, they add clutter elsewhere, which adds weight, takes up space and messes up the suspension system. Out on the highway, the suspension system is the most critical factor.

These problems will prevent electric vehicles from replacing petroleum vehicles for all but specialty purposes. The infrastructure needed for electric vehicles will never exist when limited to specialty purposes. This would be true even with the perfect battery which takes up no space and holds infinite charge.

*  *  *

1. Historical Perspective on Electric Cars, by A. Jones

2. Comparing Energy Costs per Mile for Electric and Gasoline-Fueled Vehicles.

3. Electricity Emissions. U.S. Department of Energy. Energy Efficiency and Renewable Energy. Alternative Fuels and Advanced Vehicles Data Center.

4. Electric Power Industry 2007: Year in Review. Energy Information Administration. U.S. Department of energy.

5. Electric Power. U.S. Department of energy. Energy Sources.

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Weekend press: “Green shoots visible in … ” (guess the country)

"Green shoots" … such a great term 😀  Bernanke used it to describe the early signs of recovery in the US economy, prompting soooo much hate … and yet he was right!

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So Much For That Obama Administration ‘Plan’ To “End Private Prison Use” In The US

Authored by Duane via Free Market Shooter blog,

In August of last year, Free Market Shooter wrote in support of an Obama administration directive to end the use of private prisons in the United States, one of the only policy issues the administration managed to get right:

Why, you ask, is a free market advocate in favor of ending private prisons?  Simple: because these facilities aren’t  “private” at all.


The reason why should be obvious.  Prisoners are their only “customer”, if you want to call them a customer at all; the “customers” are provided by the government, who pays private prison companies for their incarceration.


What else makes private prisons so profitable? This should also be obvious – having as many facilities and customers as possible. They have every incentive to encourage laws that keep as many incarcerated as possible, as it increases their “customer” base. Moreover, they then sell the “labor” from prisoners to companies who source prison labor at bargain basement prices, increasing their margins even further.

We all should have known the Obama administration would manage to screw this up; it just took two weeks into the job for new Attorney General and Drug War champion Jeff Sessions to flick his pen and undo Obama’s efforts:

The U.S. Justice Department has reversed an order by the Obama administration to phase out the use of private contractors to run federal prisons.


In a memo made public on Thursday, Attorney General Jeff Sessions said the Obama policy impaired the government’s ability to meet the future needs of the federal prison system.


The Obama administration said in August 2016 it planned a gradual phase-out of private prisons by letting contracts expire or by scaling them back to a level consistent with recent declines in the U.S. prison population.

And, in case you weren’t aware, this is the same Jeff Sessions who is on the record as being not only against medicinal marijuana, it is the same Jeff Sessions that has stated that marijuana is only slightly less awful than heroin:


And I am astonished to hear people suggest that we can solve our heroin crisis by legalizing marijuana – so people can trade one life-wrecking dependency for another that’s only slightly less awful.

If you investigate Sessions’ claim by examining charts of annual deaths for each drug…

…you’ll notice that “slightly less dangerous” marijuana can’t be compared and doesn’t have a chart, because it kills precisely no one…

…but fear not, this man now heads up the Department of Justice, and is responsible for enforcing the war on drugs – surely the DoJ’s resources and funds will be “properly allocated” to best serve the public and not the corporate interests, right?

Just as we did before, if you follow the money, you’ll see that while Trump’s election win might have undone the Obama effect on the share prices of the two major private prisons groups, CoreCivic (CXW) and the GEO Group (GEO)

…it took Mr. Drug War Jeff Sessions himself to kick these stocks into overdrive, with shares of both more than doubling off the pre-election lows:

We pointed out that stocks for private prisons plummeted when then-Deputy Attorney General Sally Yates ordered they be phased out last year. We reminded you that the day after Trump’s election, those stocks soared. Now, we read in TheNation that in October, just before the election, two of Sessions’ former Senate aides, David Stewart and Ryan Robichaux, became lobbyists for GEO Group, one of the two largest private prison companies, and that the two were specifically engaged to lobby on government contracting.

So, when Sessions focuses on expanding the drug war and private prisons… take one guess as to who wins the contracts:

The Trump administration has awarded its first federal contract for a new immigrant detention center to be built in Texas.


The $110 million deal went to GEO Group, a private prison company that runs 143 facilities worldwide. In a news release, GEO said it would build and run the 1,000-bed facility outside Houston under a 10-year contract that would “generate approximately $44 million in annualized revenues and returns on investment.”

And if you think this has nothing to do with the war on drugs, think again:

Sessions has long been a leading advocate for vigorous enforcement of harsh mandatory minimum drug sentencing laws that have exacerbated mass incarceration. As a federal prosecutor in Alabama, the Brennan Center for Justice found that 40 percent of his convictions were for drug related crimes, double the rate of other Alabama federal prosecutors.

What a surprise – when it comes to private prisons and the war on drugs, all you have to do is follow the money to see who still supports them.

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