More Evidence BoJ Desperate To Steepen Yield Curve

We highlighted how Bank of Japan officials have been briefing Reuters about reducing its monetary stimulus earlier than markets had been expecting – around 1Q 2018 rather than later in the year. In particular, the yield curve control (YCC) is likely to be eased from the current target of zero percent for 10-year JGB yields. It seems the BoJ became frustrated that markets had failed to respond to his hints about the "reversal rate", i.e. that central banks can lower rates too far and damage financial institutions and the provision of credit in the economy. The one (former) BoJ official who was prepared to go on the record explained.

"Reversal rate is a pretty shocking word to come out of the mouth of a BOJ governor. It's unthinkable the BOJ would insert it in Kuroda's speech without any policy intention," said Takahide Kiuchi, who was a BOJ board member until July.

The BOJ may allow long-term rates to rise more by shifting its long-term rate target to five-year yields from 10-year yields around the first quarter of next year, Kiuchi said. "The BOJ could put a positive spin on the move by saying it can more effectively reflate growth by keeping short-term borrowing costs low while allowing longer yields to rise."

We might assume that the BoJ is becoming obsessed with steepening the yield curve and we got confirmation of this overnight. A story which flashed up on Bloomberg about the BoJ tapering bond purchases at the super long end.

BOJ Bond Cut Shows Desire to Steepen Yield Curve: Merrill Lynch

Bank of Japan's slight cut in buying of bonds maturing in more than 25 years suggests its desire to steepen the yield curve, says Shuichi Obsaki, chief rates strategist for Japan at Bank of America Merrill Lynch.

Yield curve has been flattening of late and the BOJ is probably sending a message that it wants the super-long yield curve to steepen.

In terms of the mechanics, the BoJ today cut its purchases of bonds maturing in more than 25 years to 90 billion Yen from 100 billion yen at the previous offer on 17 November 2017. This was the first cut since March. JGB yields rose on the news in Friday trading, as Bloomberg reports.

JGB yields rose across the curve after the BOJ trimmed outright debt purchase in the super long sector.

BOJ reduced purchases of bonds with maturity of more than 25 years by 10b yen to 90b yen; it was the bank's first cut in the sector since March.

Purchase volume for the 10-to-25-year zone was unchanged at 200b

JGB futures closed regular day down 0.13 at 151.02; key futures suffered the biggest intraday loss since Oct. 2, losing as much as 0.21

10-year cash bond yield rises 0.5bp to 0.025%; 20-year yield gains 1bp to 0.57%; 30-year climbs 2.5bps to 0.830%

Falls in JGB futures were exaggerated by sharp rise on Wednesday

It appears that the BoJ had become panicked by the yield curve flattening after reports that the government might reduce the issuance of super-long bonds in the next fiscal year, i.e. to March 2019. On Wednesday, there was a meeting between officials from Japan's Ministry of Finance and primary dealers to discuss the plans for issuance in the next fiscal year.

While inflation is remains far below its 2% target, the BoJ is being forced into a policy reversal due to the damage its NIRP/ZIRP policy is doing to the financial sector. However, it's portraying its defeat as a victory via the supposed reflationary signalling of steepening yield curve. It's utter nonsense and a shameful reflection on the depths which central bankers will stoop to.

This Is A Paralyzed Market": Hedge Fund Turnover Drops To All Time Low

Back in July, B. Reynolds put out a contrarian piece which broke with numerous conventional wisdom norms about the state of the market, key among which was that traders are not complacent, but rather - in light of collapsing trading volumes, something which has plagued bank income statements in the past 2 quarters - simply paralyzed, as they no longer have a grasp of financial "logic" when it is all superceded by central bank liquidity injections, and as such most trades feel fake, forced and just part of the FOMO charade to avoid losing one's job. 

As Reynolds explained, "Investors are not complacent. Their stances range from extremely aggressive to bearish" and added that these "opposing forces have led to a compression of volatility. When stocks have rallied strongly, they have then been met with investor selling. When stocks sell off, the buybacks have picked up after the selling runs its course. That has been the case for more than eight years. Those forces have led to an equity bull market that moves higher in fits and starts, with some brief pullbacks from time to time. Given the positioning of equity investors and continued flows into credit, we do not see that pattern changing for some time." Meanwhile, sandwiched inbetween these two trends, investors - both retail and institutional - find themselves in trade limbo, and the outcome is a gradual decline in trading volumes "which is more reflective of paralysis than complacency among equity investors."

And while one can posit theories explaining this bizarre market until one is blue in the face, the most vivid confirmation of Reyonld's "paralysis" thesis emerged in the latest batch of hedge fund 13Fs, which was analyzed by Goldman earlier this week, and noted here in "These Are The Top 50 Hedge Fund Long And Short Positions." 

In the report, Goldman highlighted various notable outliers, such as the latest record high in hedge fund leverage...

... coupled with the recent plunge in short interest (which as a share of S&P 500 market cap sits just below 2.0%, matching January of this year as the lowest level since 2012)...

... even as hedge fund "crowding" in a handful of top names hits an all time high: 

But the most interesting to us, and the hedge fund community, we believe is the following chart, which shows that hedge fund portfolio turnover continued its downward trend and reached a new record low in the third quarter Across all portfolio positions, turnover registered 26% in 3Q. Turnover of the largest quartile of positions, which make up the vast majority of fund portfolios, fell to just 13%.

This means that once hedge funds have established positions, they no longer trade in and out, but simply lean back and let it ride. And why not: with the most popular hedge fund positions this year being also the best performing ones, namely Facebook, Amazon, Alibaba, Alphabet and Microsoft, why ever both selling. Indeed, as the next chart shows, the bulk of the collapsing turnover is largely due to tech stocks:

Of course, this strategy of loading up on winner and letting them ride is a two-edged sword. while it is the best strategy on the way up, it also becomes a quasi private equity strategy, in which the price formation is created on the margin with increasingly less volume. And, since such tech holdings are becoming ever more illiquid, the threat is what happens once the narrative shifts and instead of buying, hedge funds start to sell these most concentrated of growth names. One could say that a tech selloff is emerging as one of the more concerning black - or at least gray - swans in the market. In fact, we are did say just that...

Facebook, Amazon, Alibaba, Google, Microsoft are the 5 most widely held HF stocks. Tech selloff = black swan

China Deleveraging Hits Corporate Bonds As Cascade Effect Begins

Following the market lockdown during October's Party Congress, many commentators were disturbed by the continued rise in Chinese government bond yields as we returned to "business as usual", with the 10-year rising to 4%. People noted a useful insight from the Wall Street Journal.

An important anomaly to note about the bond rout: as government bonds sold off, yields on less-liquid, unsecured Chinese corporate bonds barely moved.

 That is atypical in an environment of rising rates – usually, bond investors shed their less-liquid holdings and hold on to assets that are more easily tradable, like government debt.

The question was…why had corporate bond yields barely moved? The answer, according to the WSJ, was that China's deleveraging policy led to redemptions in the shadow banking sector, e.g. in the notorious $4 trillion Wealth Management Products (WMP) sector. Faced with redemptions, shadow banks had to sell something…quickly…and highly liquid government bonds were the "easiest option". Furthermore…and this is potentially significant…the WSJ noted.

Meanwhile, the nonbanks have held on to their higher-yielding corporate bonds, which at least have the benefit of helping them to maintain high returns.

Not any more (see below).

We agreed with the WSJ's explanation at the time, but noted that the government bond sell-off was actually a sign of the unravelling of the WMP Ponzi scheme. The Chinese authorities are wise to the Ponzi which is why they announced the overhaul of shadow banking and WMPs last Friday (see "A 'New Era' In Chinese Regulation Means Turmoil For $15 Trillion In China's 'Shadows"). However, the new regulations don't kick in until mid-2019, a sign to us that when they looked "under the bonnet", they didn't like what they saw.  

We doubt that China can achieve an orderly restructuring of its shadow banking sector, never mind its much larger credit bubble. A sign that we have taken another step towards China's "Minsky moment" is that the bond sell-off has spread to the corporate bond market. The chart shows how spreads versus sovereign bonds have blown out during the last few weeks.

Bloomberg noted how the 10-year yield on China Development Bank notes, a quasi-sovereign issue, closed above 5% for the first time since 2014 today while, in another report, it put the corporate bond sell-off in a wider context.

China's deleveraging campaign is finally starting to bite in the nation's corporate-bond market, a shift that will make 2018 a clearer test of policy makers' appetites to let struggling companies fail. Yields on five-year top-rated local corporate notes have jumped about 33 basis points since the month began, to a three-year high of 5.3 percent, according to data compiled by clearing house ChinaBond. Government bonds, which have far greater liquidity, had already moved last month as the central bank warned further deleveraging was needed.

With more than $1 trillion of local bonds maturing in 2018-19, it will become increasingly expensive for Chinese companies to roll over financing — and all the tougher for those in industries like coal that the nation's leadership wants to shrink. Two companies based in Inner Mongolia, a northern province that's suffered from a debt-and-construction binge, missed bond payments on Tuesday, in a demonstration of the kind of pain that may come.

Bloomberg tries to put a positive spin on the corporate bond sell-off, defaults are healthy in terms of differentiating good and credits.

In the long haul, that all may be good for China. Allowing more defaults could see its bond market become more like its overseas counterparts, with a greater differentiation in price. And that could mean it channels funds more productively. "The deleveraging campaign and the new rules on the asset management industry will further differentiate good and bad quality credits, and make the onshore credit market more efficient," said Raymond Gui, senior portfolio manager at Income Partners Asset Management (HK) Ltd. "Weaker companies will find it harder to roll over their debts because funding costs will stay high." Gui predicts yields will keep climbing. The average for top-rated corporate bonds is already 2.2 percentage points above what investors demanded to hold them in October last year.

The rise comes as authorities show greater determination to shift the economy onto a more sustainable footing, with less debt. The latest move was a plan to discipline the asset-management industry, including banning guaranteed rates of return. People's Bank of China Governor Zhou Xiaochuan graphically depicted the risk of excess leverage, by evoking a "Minsky moment," or sudden collapse of asset values. Key to that endeavor will be scaling back some of the implicit credit guarantees that have backed a broad swathe of Chinese borrowers. The country only started allowing corporate defaults in 2014. Last year there was a record, coming in at at least 29. It's unclear yet whether that total will be met in 2017.

Bloomberg spoke to an analyst who also believes the recent sell-off in Chinese bonds is more to do with separating the "wheat from the chaff", rather than anything more profound.

"We expect the divergence of performance between different bond categories (Chinese government bonds, policy bank bonds and credits) to become more prominent into 2018," Albert Leung and Prashant Pande, rates strategists at Nomura Holdings Inc., wrote in a note Wednesday.

We disagree. From our perspective, it looks like early signs of cascading sell-offs within Chinese financial markets, which have long been abused by excessive leverage and Ponzi characteristics. Talking of which, the Shanghai Composite Index suffered its biggest one-day drop since June 2016.

What caused the sell-off? According to some commentators it was fear that the local bond rout was getting out of control…hence "cascade". We noted that traders had been stunned by the official warning from Beijing that some stocks – in this case Kweichow Moutai – had risen "too far, too fast". Zhengyang Shen, a Shanghai-based analyst at Northeast Securites commented.

"The decline in Moutai has triggered selloffs in some of this year's best performing stocks."

Which sounds an awful lot like another example of cascading selling…