Surveillance: BOJ Surprise with Lyngen

this historic day. With the Bank of Japan capitulating towards a strategy like the Bank of England, the ECB and the Fed as well. Dominic Constant with us earlier, many people writing in an Hilarian in the nine o'clock hour, and now Ian Lincoln with us out of us right strategy at BEMO Capital Markets. The good news is he

can't drust straight line. So Ben Jeffrey took the Technical Analysis award from Institutional Investor and his colleague Lincoln picked up all the other pieces economics and strategy in the fixed income space. Ian, what did you write this morning? First of all, congratulations on the I I love fest. Uh, you've wanted I think as many times is ed Hyman. And you're a little bit younger I want you to explain to us your first blush of this historic moment. Well,

thanks for congratulations, Tom, I appreciate that. In terms of the Bank of Japan, I think the most surprising aspect of it from our perspective was, yes, the timing, but to some extent that they lasted this long. When we think about what the rest of the world has been engaged in over the course of it's been collective tightening, coincidence perhaps and not coordinated. But the thank the fact of the matter is that Bank of Japan is now engaged.

I stole from the foreign exchange space being capital markets pretty darn good there as well. With Greg Anderson. You know, I I look at the sterilized nature of this. We're gonna make the move, but we're going to increase bond purchases.

Twenty five explained that. But to us and what that means for global finance, I think that their decision to increase the bond purchases was them implicitly acknowledging that someone's going to try to push that fifty basis point upper bound and to do that, they're going to need to have the cash there to defend it. So that move was a bit more intuitive than I think that the headline might have otherwise implied. How sustainable do you think

that says? So? I think that the Bank of Japan is going to run up against the reality of needing to be more aggressive than they have been as the two thousand and twenty three calendar unfolds. But I don't think it's going to be as quick as the market would like to see. We're hearing Jennie's out of the bottle. Jennie's out of the bottle. This gets tested, new confnant comes in, They're gonna have to make another move. How would you think about and new confin to come again?

Corronto exits, April happens, What does that look like? From what I understand, the front runner at the to replace for the Bank of Japan is very much in keeping with the overall mentality of Banka Japan. So I wouldn't expect any massive policy shifts. But even if that were the case, the groundwork has already been laid for a bit more of a hawkish move, and so I wouldn't be surprised to see out of negative rates sometime in

the first half of the Bank of Japan. Your shop has the advantage of GALLO, and he's reporting into Greg Anderson, who's just flat out legendary in tertiary foreign exchange analysis. I don't know if you've spoken to Mr Anderson this morning, but the idea of a presumed glide path of strong yen from one fifty two modeling out even lower. Does he have a conviction that that glide path can sustain

or is it overplayed? I think that his biggest takeaway is that momentum has shifted and that the progress toward the ultimate goal is going to be on autopilot to some extent. So I think there's a high conviction on

the glidepath. Will they have the economic might, the animal spirit of nominal or inflation adjusted that dynamic of inflation of real g d P to allow for these trends to occur and the unwind of their debt ownership, well, I do think that the trajectory that's currently in place suggests that they'll be very little problem getting there, although ultimately we need to see how the first quarter shapes

up in Japan. We need to see what the impact from a reversal of the end, if and when it eventually occurs, is going to be for inflation in Japan. Have you changed the treasury coll off the back of this, what does it make for the treasury market? We haven't changed your call. We still think ten year yields in two thousand twenty three three, I think that's a relatively benign forecast given where we are in the overall interest

rate cycle. And the one thing that I would emphasize there is, at the end of the day, that's a FED credibility call because we have break evens compressing back to levels that were in place prior to the pandemic. And the biggest risk is that the FED, which we don't think they'll do this, but would be that the FED gave up the two percent target and we just don't see the path for them to do that. Well,

that's a longer conversation for another time. So three on tens talk to me about where that is relative to fend funds and the front end of the curve. I think that the biggest surprise for two thousand and twenty three is going to be the fact that both two and ten year yields can trade well below effective FED funds.

We've already seen that start that typically doesn't occur until we're later into the cycle and the FED has reached terminal and terminal has been in place for a while, so we actually don't see any rate cuts in two thousand and twenty three, but we see deeper inversion of funds versus twos and funds versus tens. Did you just say that the terminal rate is wherever it is in both twos and tens will be below that price up

yield down? Absolutely, that's what's in place right now. And you also you also implied it could be as much as two basis points, and it historically has precisely. So what's your path, what your outlier on where the tenure yield could be? So if I'm wrong, I'm wrong in one of two ways. One is I have underestimated the Fed's ability to keep policy on hold well into two thousand and twenty four. We're assuming they make it through twenty three twenty four. They needed to adjust and they

started laying the groundwork for that. That would imply that there could be more upside, obviously in the front end of the curve. The flip side being that we've underestimated the extent of the recession that we might see, we're looking for a more pedestrian, benign version of soft landing. But if we got that wrong, then you could see to handle on tenure yields relatively easily. And I think

you're brilliant. I've never seen someone so calmly explained something that is actually a monster coldeerious, a serious, serious cold and in sub common bat explaining, you know. And and I had the great joy of knowing Fred we Gold when he was at Bloomberg and of course at the Walsters Journal. And these beauty contests are not a small matter in stitutional investor in the Wall Street Journal U the way they do the equity market contest, this is really really hard. And part of it is not only

making a call. It's a delivery in Lincoln, does it? I believe it's in English? Is what we call it capital markets. Our team has been working since one am on this in London, in New York, and we are thrilled for Global Wall Street now to bring you Dominic Constant. He's head of macro strategy at the Japanese bank Missooo. He is at Missooi America's I want to make clear that he is not speaking for the management of Missooo Bank that would be inappropriate for those of you in

the United States. Missooo is nine roll up of three banking giants in Japan. Missoo translate as golden ears of rice, and all ears at Missoo Tokyo are attuned to the monetary policy of their Japan. Dr Constant, thank you so much for being with us today, Dominique. It's just as simple as this. Given the zombie nature of the Japanese economy for twenty years, the dearth of nominal GDP, the bouts of disinflation and outright deflation. How constrained is this

Bank of Japan forward? How many degrees of freedom have they lost in the lost decade? Well, I mean they are clearly constrained in terms of the idea that they're gets a sort of normalized, you know policy in any way that we've seen it elsewhere. UM. But I think the time complearly the the the idea of the UH, the targeting the tenure yield and having negative interest rates, those those days are numbers. The market is now pricing for positive interest rates next year. UH. And this is

basically is letting the genie out for the bottle. UH. And I think it's something that we all expected, but the timing was obviously unexpected. I mean, the bj could have done this earlier than the year, when the end was under a lot of pressure. That was the obvious time to do it. I mean we were pricing for positive rate hikes or positive rates I should say, at the front end back in June of this year. So the idea is that they brought this forward. They're doing

it before Corona is obviously stepping down. I guess there there's certain reasons why they're bringing it forward, um related to the fact that perhaps they see an opportunity to do it now, better to do that before the Fed is actually reversing course on their own rates past, perhaps as as priced by the market. I think that's that's a logic behind some of this decision to go earlier. If there is a bet of disinflation, two bouts of US inflation, is stasistics better even in the United Kingdom,

a little bit of a whisper of better inflation. Is this a bet by the Bank of Japan at three point seven percent nationwide CPI can come in. I think that's that's very interesting. I mean, basically, you know, we are seeing Japanese inflation rising now is going to be around four percent. The focus on the inflation from our you know, from our Japanese colleague has been really around

the wage side to it. So the large wage negotiations start taking place really in spring next year, so that some of the logic called delaying any move was to see kind of how those wage negotiations lets go. Because the inflation you're seeing now in Japan is really very much important from the you know, the weakness in the end uh and uh. And it's the extent that that becomes self fulfilling because say, wages are allowed to rise.

That's the big uncertainty. So my guess is UH, one read from the decision to move earlier is there are clearly is against be an expectation now that you are going to see some wage growth finally, some decent wage growth, at least in line perhaps with inflation exactly the doctor Coustom you've written must read essays unquantitative easing and quantitative tightening.

And then there's a government with fifty to eight percent ownership of domestic bonds, a government looking at a fiction of a debt to GDP ratio out near two D thirty two and fifty. Do you have a confidence that Japan can unwind those two extreme positions. Yeah, I mean,

to be honest, we do. I mean and and and the reason the reason it's obviously if there was a really a shock uh widening in the band or you get just getting rid of the band and allowing as ort of free fall in the in the market, then then obviously that would have raised concerns, uh, you know, for for the you know, the debt holdings of Japanese financial institutions and how well hedged they've been. I think over the course of this year probably hedging has been

actually you know, put in place quite actively. We also know that, for example, in the throne bond holding, the Japanese institutions have been very cautious around the interests that the increased in interest rates globally. So I think the concern around sort of financial stability related to a sort of shock move in interest rates has has diminished in

recent months. And the fact that you know, they are only moving twenty five days points and it's not a you know, it's not massive, and the back end has obviously moved a lot before anyway, So I think that perspective, you know, um, you know, there's relatively more comfort uh from you know, from this unwind and constitive uh easing.

I think that the issue fundamentally though for Japanese finance institutions, because they need to obviously get their sort of loan deposit ratios are back in order and sort of reduced their alliance on g GB holdings as as a large part of their the assets side of their balance sheets.

And you know, that's going to take a long time. Uh. And I think you know, you know, I I think, you know, normalizing interest rates at the front end in a sustainable way because inflation is higher and nominal growth is basically more sustainably higher, that's gonna be the way in which the Japanese banks will restructure their balance sheets going board. It's going to take a while. You know, we're not going you know, we're not having a massive

rise in interest rate. I think fair value and JGBS, according to our JGB structs, is around teenty five based points in ten years. So you know, you've basically done half of that move basically by today, and and no doubt we'll you know, get the other half in due course, but probably not not until that the bj A has actually lifted the overnight race as well. There will be a lot of people waking up this morning thinking, well, what does this mean for me? Why should I care?

Don What does this mean for global markets outside of Japan? Well, I mean that's really important, and and you know we all had that thought is like oh my god, you know sort of what what does what sense is actually need global ones? The first thing that obviously occurs to a lot of people is that we've already sold off global bonds massively without the Japanese markets really being that involved.

So the old days, when Japan would move aggressively, it was often seen as a bit of a harbinger for a global bond sell off, and that was all related to things like the yen you know, repatriot Asian trade, which related to a Japanese holdings of foreign bonds that they basically needed to bring back because they were less attractive. They're heading costs that kind of undermined their attractives, etcetera.

And so that was always concerned. What we've seen really this year is the marginal flows in Japan have obviously been zero actually negative. Maybe next sellers of global bonds quite know, quite impressively, so um and um. That's partly because as the bond market has sold off globally with the ECB and the Fed raising rates and relatively aggressively. Uh, you know, it doesn't it's not attractive for them to

be overseas. So my guess is that the impact basically is gonna be somewhat much more muted now and so far that's already been the case. And it's just that, you know, these guys have not been exposed as as as they might have been in previous titles. So yes, it's a it's a it's a small negative called global bonds. But it shouldn't see you know, we shouldn't see a sort of you know, a kind of collapse in bond markets higher you know, yields higher, uh, you know, on

the back of this normanization. That would be my my my initial taken were going back ten years when we used to look at that data for Japanese investors and where their money was going, how many bunds they've bought a board. Are we looking at that every month again? Yeah? I mean we can do, but I mean they've been really flat line now for for a while certainly this year, so we can definitely sort of look at that. I mean, there are there are important I think that you know,

there are there are important things also consider. I mean, the the attractiveness of UM, the JGB market relative to uh, you know, treasuries UM, you know, on a hedge basis

is still quite you know, it's still quite impressive. So I think we know, basically the Japanese investors have are being encouraged to sort of stay at home relatively speaking, which is one of the reasons why you could argue that b O J can have a fairly orderly exit at this stage because you know, jgbs are you know, attractive and now even more attractive, so so you know, yeah, I mean I think we can definitely sort of look at that data but in the back, but I don't

think it's the same, you know, with a slightly different world, partly because of the you know, the different speed with which these central banks have been moving. Without a doubt, Donic, this was awesome thanks to us today, Dominic Constant of Missouri, just have wonderful line. We've got a fantastic guest around the table with us this morning. Happy to say that Cassy Barrow of JP Morkan Asset Management joined US fixed income portfolio manager. Cassy kind of go to that question.

I think they go to question in the morning. Is it a step towards so called normalization or just resetting the policy stance for something more sustainable. Which one is it? So we did feel that the Bank of Japan's policy was unsustainable. It was time for a move by them. We think that it was important that they did it now.

They could have waited until January, but they didn't. And so what we see is a policy rate or a ten year yield around of fifty basis points is actually fairly consistent with the ten ure yield that that we have right now. So we don't necessarily think that this is a huge story for the treasury market. Where we are expecting to see a lot of flows is in Europe, So we do expect European bonds to sell off on this. That's where you're going to get that repatriation trade from

the carriage. So this is the Japanese demand that you think is going to wind the Japanese demand that was going into European bond markets. Is that a problem for buttons A problem for the Italian bond market. Where is it the bigger problem? Well, I think in general we've seen upward pressure and yields across Europe. And I think it's really interesting that you had the Fed try to be as hawkish as it possibly could last week and

they weren't able to tighten financial conditions. And finally you have the E c B and the b O G, B O J come to the rescue and get financial conditions to tighten. The Fed is not going at it alone. Um. I think that that is actually a positive for bond investors next year because global inflation is going to come down and we're seeing these yield rises as an opportunity to buy bonds and to leg into long duration positions.

Have the great fortune of sitting across a desk from a guy who I think saw the financing World War One. But Michael, I mean, it's just it's amazing what you're dealing. It was both a compliment and wasn't it was. We're working on thank you. The bottom line is everybody watching and listening. He's seen a minus thirteen percent Bloomberg total return. It is now negative six percent annualized two years now six percent down six percent down? How long does it take for me to get back to even if I'm

running an adult bond portfolio? Do you and Bob look at it is a two year exercise? Or dare I say? Is it a five year exercise? Right? So, I think the question you're asking is very important because we talk a lot about what's going to happen in the next one week, two weeks, three months. But when you look at a let's just say twelve month horizon and what you can potentially get from a bond portfolio over the next twelve months, Let's just look at the global aggregate.

For example, the yield is around five percent on a US dollar hedge basis and if you have let's just say a modest fifty basis point rally and yields over the course of the next year, you're getting high single digit returns on that portfolio next year. So that is why kind of across the board you're hearing people say not just bonds are back, but as we like to say, fixed incomes fashionable again, fixed in comes fashionable home. Would you make of that? I'm here in the equity guys

talk at fixed in come along. Yeah, yeah, I'll go with that. You know, you see it behaviorally and culturally. Folks, when you're walking down the street in New York, that's like eighteen months to get my portfolio back to zero, is what I'm looking at. Where do you do that across the continuum? Do you use full faith and credit? Is that I G value or do you have to go to the land of Brammo and distressed. We are sticking with high quality UM that has Did you see

the TV show Brammo Barrow? It would be just it would be just with the oil all of LASA back in the day. Yeah, but Brim o'bara would be a great one hour fixed income distressed at you know, be a great show. Okay, it would be good. Excuse me, I interrupted. Absolutely, I'm just letting to carry on the right to ignore it. So we are focusing on high

quality UM. You know, when when we look across the opportunity set, with risk free rates significantly higher, you don't have to extend into those sectors UM to get the yield that you want to. So UM, we're thinking about agency mortgages, We're thinking about investment grade credit, We're thinking about securitized credit that's higher up in the capital structure. Okay, I haven't answer this question. I think in like seventeen years, what does issuance do? What does i G quality do?

Do they mean all the CFOs were down, we could low yields the loving it? How do they reset? And will JP Morgan see issuance in the next twelve months? So they are going to have to continue to issue, but generally banks have to or banks as well as the most of the i G universe have termed out their balance sheets and they've made themselves put themselves in

a very good position high cash balances. Uh, they've extended out that debt um and they've put themselves in a position where going into an expected recession, we've we've never seen corporate fundamentals to be better. Can I finish on the yold code then? Because when I said lost spike to Bob, he thinks we're gonna get some real spread widening in a recession on high yield. Can we finish that?

What are your thoughts on that? Now? We are still expecting that spreads are going to continue to widen here, So if you look at four hundred basis points range on hot yeld spreads, what we're thinking here is Yeah, if we do get a soft landing, these spreads are

are reasonable. But our expectation is that with the most aggressive central bank tightening that you have seen since the nineties, eventually this is going to bite and inevitably, um, when the recession comes, spreads are going to to widen further from here. This was great Calsey, not more often. This is just fantastic love Cancy Vera from JP Morgan. Let's get to wind Thin on this, the global ahead of Currency Strategy at Brand Brothers, Hanahan win Thin. Thank you,

sir for being with us. What do you make of these moves from the b LJ this morning? Well, first of all, thanks for having me. I have to be honest. When I went to see last night, I was worried they wouldn't have anything to talk about. And lo and behold we get a nice, nice, big surprise. Um. I'm i am one of those fifty some economis who expected nothing. This was a shock. Um. The Bank of Japan tend

to like surprises, even in this incredibly volatile environment. So once again central banks are adding to global bal Ultimately, not just the b o J, we have every central bank around the world it's literally adding to all market of alatility with the policy actions and Ford didance. So it's a tough, tough um sort of road to to travel for the investors. But bottom line, it's clear that banquet Japan is gonna hike next year. We had second

half of next year, Pennsylvan. We thought again, like like consensus, new governor comes into April, he does a review second half rate hike. But I think that's moved timetable much further head. I think we get something as soon as Q two once a new guy is maybe in Q one if Carota wants a surprise again. So the global monetary tighten train rambles on, and that's that's bad for risk uh and sort of markets have been so used to zero liquidity, I'm sorry, zero rates and abundant global liquidity.

So when you think this is a step towards normalization, it's not just about making a more devish stunts more sustainable. Absolutely, Corota can deny it all he wants, but this is a clear step. And I would go back to my e M experience, like once you start messing with the PEG, the markets spelled smell blood in the water. Um I suspect this zero point five range will be tested very

quickly and very aggressively. Uh. And I think the bankut Japan is that genie out of the bottle, perhaps a little bit too soon, as you know that the big movement is has been in the FX market, and I think that's where we'll continue. We'll see that the real moves. But making no mistake that the martial test this this new sort of PEG arrangement and dr sin with great respect for your Burmese heritage. Saving face, I believe is Anna. I hope I'm pronouncing that correctly. It's Hontreo up in

Tokyo as well. And what I see here is a massive exercise culturally for the Bank of Japan is a domestic institution. To save face, how does the culture of this forward to April and the new governor fit in explain the political calculus of the Bank of Japan is a stagger to April. Sure, Tom, it's it's we had um hints that there's some sort of policy review sooner

perhaps rather than later. But really I think the markets really pro proved this because face it, government Corota has been uh devoutly dubbish throughout this this episode of higher inflation. So it is strange to me in sort of saving face to be saying one thing, you know, with certainty and all of a sudden surprise and markets. So again, I think sort of reality sort of took took precedence over sort of appearance. That is, they really couldn't keep

this going much longer. Um, we got it. We have a CPI print coming out on Friday. It's like the show Throw the Rise with Chord headline that he became hard, harder and harder to sustained this facade that that they're going to keep keep things as is. Yeah, so it's it's a tough it means very tough to break now again once once this genie is out of the bottle and all bets are off for mere mortals away from the dynamics of monetary policy and theory, what is his

dominant constraint? Is it fiscal debt to GDP migrating to is that the inflation rate you speak of? Is it end dynamics as a China? What's then straight you're focused on Tom I said to be honest, and this is not being self as all the above. They're juggling so many targets with very few instruments. UH and central banks around the world have gotten involved in the way way beyond sort of their the remit um I believe so

as you. I think the main thing is you point out with the debt GDP ratio right there, they've been they own half of all g g g gbs, as Johnathan pointed out, and certain tranches. Once the UH interest rates start going up, those barring costs are going up sharply. Right. That's the one thing that's kept the whole ball of wax going is that they've been issuing debt, buying debt, but at really low UH you know, sort of sub

market rates. If the ten year deal goes to from zero point went up to even one percent or two percent, which is not out of the question, all of a sudden, the debt burden jumps. Now on the other side, this and this is what where my head starts to really hurt. It's hard to explain, harder heart explaining. Well, half that is how by the government. It's not like it's held

by foreigners and there's a run on hand. So it's it's a strange, strange construct that's developed over the last two decades, and my feeling that they tried to keep us going sort of the can down the road. I thought they're gonna do more kicking than they have them. But it's a shock that they moved to theare went just briefly, that phrase, the genie is out of the bottle, It's not the first time I've heard it this morning.

I think a lot of people share that sentiment. My question would be, if that's the case, why aren't we testing the upper limit of that band this morning? Why aren't we up at fifty basis points on a Jampanese tenure. Why do you think that is? I would say it's too soon to say. I mean, you know, this literally just happened hours ago. Give us some time, you know, as you know these big markets, it takes some people, uh,

some participants time to sort of digesting. But I think when all the dost settles, um, it's pretty clear that you sell jgbs and by the end, you know this is in terms of the risk, you know why they put up I think they did not want to risk a strong end and we have to talk about but perhaps, I mean, you know, nore On Dolly Inn. Let's take one thing step with time, but strongly. Yeah, at this point I think is a pretty uh shure thing. When this was a pleasure, Thank you, said of grand brother's

handy man. This is the Bloomberg Surveillance Podcast. Thanks for listening. Join us live weekdays from seven to ten am Eastern on Bloomberg Radio and on Bloomberg Television each day from six to nine am for insight from the best in economics, finance, investment, and international relations. And subscribe to the Surveillance podcast on Apple podcast, SoundCloud, Bloomberg dot com, and of course on the terminal. I'm Tom Keene, and this is Bloomberg