The third leg of the Abe Trade is finally kicking in: Japanese government bonds have begun to sell off. Last fall, ahead of Japan’s elections, Shinzo Abe began to emerge as the likely winner with a radical agenda for change. McAlinden Research mapped out how Abe’s strategy, if successful, would lift stocks but undermine bonds and the yen. Since Abe’s victory, stocks have surged and the yen has plunged. But government bonds had been holding up despite the massive shifts in fiscal and monetary policy.
Last month, JGB yields hit an all-time low of 0.4% and have been grinding up ever since. The market is recognizing that the new government’s reforms are credible and mark an inflection point for the economy. Japanese investors are already reallocating overseas. Although the coincident economic data remains mixed â€“ industrial production is still weak while retail sales are improving â€“ the OECD’s leading indicators are turning up and the latest purchasing manager survey is back in expansion. After years of sluggish growth and persistent deflation, stronger growth and rising inflation will push nominal yields higher.
The government’s stimulus policies have been helped by the rally in stocks and the sell-off of the yen (just ask the exporters), but policymakers won’t want to see rates rise too high or too quickly. If that happens, the Bank of Japan might intervene and buy even more bonds to slow the rise in yields. Whether slow or fast, however, yields are going up and bond prices are going down. The Abe Trade is now firing on all pistons with quite a long way yet to go.
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Warren Hatch, PhD, CFA
Chief Investment Strategist
McAlinden Research - a division of Catalpa Capital Advisors, LLC