Markets Stabilize, Japanese Continue to Sell Foreign Bonds

The global capital markets have stabilized after yesterday's moves.  The major foreign currencies and most of the emerging market currencies are consolidating yesterday's moves.   Asian equities followed the US lower, with the MSCI Asia-Pacific Index off almost 1.25%, but European bourses are higher, led by technology and health care sectors.  Investors appear to have largely ignored yesterday's Egan-Jones downgrade its credit rating for Germany.  Germany's 10-year bond was auctioned at record lows yesterday and yields 1-2 bp higher today in line with other core bonds.  

The dollar was confined to relative narrow ranges against the yen and Tokyo-based participants were on both sides of the markets.  The long-end of the JGB market was supported by favorable reception to the 20-year bond auction, which was a relief after the dismal 30-year bond auction last week.   The BOJ met with JGB dealers yesterday and the outcome seems to be that the central bank will look to make more frequent operations that will be generally of smaller size in a bid to ease the volatility.  

Contrary to claims about Japanese buying of foreign bonds, the weekly MOF data continues to show the opposite.  In the week to April 13, Japanese investors were net sellers of JPY332 bln of foreign bonds.  They also sold JPY158 bln of foreign equities and a whopping JPY5.87 trillion of foreign bills.  As we have noted, the sales on a net basis does not preclude the possibility that Japanese investors were net buyers of a particular country's bonds, but there is no official data on the country breakdown since February.  

For their part, foreign investors continue to add exposure of Japanese equities, accumulating another JPY1.57 trillion of shares.  They have been net buyers in 21 of the past 22 weeks.  The general pattern is that some of the equity purchases are funded by the sales of bonds and bills and this remained true in the report released today.  Foreign investors sold JPY176 bln of Japanese bonds and JPY265 bln of Japanese bills.  That said, the currency exposure on equity investments tend not to be hedged as much as bond exposure, though we note that one of the most popular ETFs lately has been (DXJ) which gives one exposure to Japanese stocks, but with the currency risk completely hedged. 

The G20 meeting is set to begin shortly.  We think it is clear that Japan will not face much criticism.  Its attempt to reflate appears to have been supported by the IMF and US Treasury Secretary Lew (and we would argue last week's Treasury report also endorsed current Japanese actions).  The ECB and the Bank of Canada also seemed supportive.  

Italy's parliament and regional representatives are meeting to select a new president.  This will bring a Italy closer to a new government.  The procedure could take a few days as just two rounds of voting are held each data.    The first three rounds requires a 2/3 majority, but after that the threshold is lowered to absolute majority.     The new president will likely launch another round of consultations among the main parties before 1) giving some one a mandate to form a new government, who can secure a majority in both houses, or 2) install a new transitional government or 3) leave Monti's caretaker government in place to carry out a specific agenda before calling a new election.   

The best thing for the markets is a resolution tomorrow on the third ballot.  If the center right and center left can agree on a presidential candidate it might be a seen as a sign of the possibility of a broader political agreement..  Italy's 10-year bond yield is down to 4.20% today. This is the post-election low.  The post-election high was just below 5.0%. Over the past month, Italian bonds across the curve have outperformed Spain by about 10 bp.  The 2.3% decline of Italy's equity market makes it the best performer among the major European bourses over the same time. 

The UK reported March retail sales today in line with expectations.   Sales fell 0.7% after the outsized 2.1% rise in February.  ONS said that the coldest March in 40 years dampened the sale of spring goods, which suggests a better April sales.   Over the quarter, retail sales rose by 0.4%.  The first look at Q1 GDP will be on April 25 and flat or small positive number is possible.