Bond Outlook February 14th

Long has it been recognised that capital flows have been driving macro-economics, notably in keeping the USD from falling drastically – as it would on a purely current account basis – and preventing long-term USD yields from rising. In addition, the current imbalance in the world economy is seen by commentators as unsustainable, even though financial markets seem to assume that it is. We therefore see it as one our duties to scan continually for events, rumours or trends which point to a change in the status quo.

One of these has to be the low value of the JPY. The more it falls, the greater will be the disruption when it recovers because of the reduction of carry trades. We see a knock-on effect on the cards for the CHF, i.e. if the JPY rises, so should the CHF, as carry-trades with both currencies are unwound. This threat to stability is by nature one of a sudden and unexpected impact. All seems well, until a surprise event, like the Japanese Government yielding to the pressure from the G7 that it cease manipulating its currency (by telling the BoJ not to raise interest rates).