Japan's Sell-Off

by Michael J. Howell30. May 2013 19:58

A 15% drop in just a few days focuses the mind. Is Tokyo's rally bust already? Not a chance, in our view. Nerves have been twanged by the sharp jump in JGB yields and associated steepening of the Japanese yield curve. But a steep yield curve is exactly what QE and liquidity policies should deliver. America since 2008 is a clear case in point, but the evidence is overwhelming and true throughout history and across geographies. In fact, this is how bond markets work. Forget all the talk that Central Banks push down yields by buying bonds. In a micro sense they do, but economics and finance are more about macro events. A steeper yield curve reflects fatter risk premia and fatter risk premia on bonds are the very reverse of slimmer risk premia on stocks, or should be if the monetary stimulus works. In short, bonds always sell off and enjoy these fatter risk premia when investors expect a return to 'better times'. Therefore, a steep yield in Japan, as in the US and Europe, signals coming economic recovery. Sell bonds, buy stocks. This is an unexpected opportunity for equities.

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