Last year it seemed like all that any macro trader wanted to talk about was Japan’s imminent decline into a hyper inflationary currency death spiral. Links to slick presentations from the likes of Kyle Bass and others filled my inbox on a daily basis.

It was no surprise that the macro traders were focused on Japan – the election of Prime Minister Abe had ushered in a dramatic new economic program dubbed Abeconomics that promised to break the decade long deflationary morass. Over the space of the next few months, the Yen had quickly declined from 77 to 102, reaping huge profits for the hedge funds that were short Yen.

However since this dramatic Yen weakening, the action in Japanese assets has become strangely quiet. The imminent collapse of the Yen and the often predicted hyper inflationary spiral have failed to even peak out from under the covers.

http://themacrotourist.com/images/Azure/JPYJun2514.pngUSDJPY Rate (higher means weaker Yen)</a> </div>

The Yen has basically gone sideways for the last year and a half. As for the other half of the often predicted Japanese macro theme – rising rates due to runaway inflation, the trading in the JGB market has also gone quieter than a funeral.

http://themacrotourist.com/images/Azure/JB1Jun2514.pngJGB Futures trading</a> </div>

Trading has become so slow that on days where the Bank of Japan is not engage in any Quantitative Easing, there has not been a single trade in the JGB cash 10 year market.

There has been lots of reasons to explain this contraction in volume and volatility. But the main reason is that the Bank of Japan has increasingly become the dominant player in the bond market. As the BoJ continues with their aggressive QE program, they remove more and more bonds from the market place.

Although I have long argued that QE programs are inflationary and ultimately cause bonds to fall in value, so far the Japanese bond market has defied this theory. There was indeed a little “inflation” scare when Abeconomics was announced that caused the JGB market to hiccup a little, but since then yields have steadily chugged lower.

http://themacrotourist.com/images/Azure/Japan10Jun2514.pngJapanese 10 Year Yield</a> </div>

It is all the more strange as Abeconomics has actually been quite successful in producing inflation.

http://themacrotourist.com/images/Azure/Japan10vsCPIJun2514.pngJapanese CPI YoY (yellow line) vs JGB 10 Year Yield (white line)</a> </div>

This has created a situation where real 10 year rates have gone massively negative.

http://themacrotourist.com/images/Azure/Japan10RRJun2514.pngJapanese 10 Year Real Rate</a> </div>

This means that holders of 10 year Japanese bonds are now receiving an interest rate that is almost 300 basis points less than inflation! I understand that Japanese inflation has spiked due to an increase in the sales tax that pushed a lot of consumption forward, but with 10 year yields offering a measly 60 basis points, there is not a lot of cushion in terms of real yield if there is any sort of inflation.

Even in the darkest days following the 2008 credit crash, the US 10 year real yield never got below negative 200 basis points.

http://themacrotourist.com/images/Azure/US10YRRRJun2514.pngUS 10 Year Real Yield</a> </div>

Think back to point when the US 10 year was yielding 200 basis points less than inflation. At that time everyone, and I mean everyone, was moaning about how rates would never ever rise again. If you even suggested that bonds could go down instead of up you were labelled a heretic that just didn’t understand the new financial order.

Well, shorting that overwhelming consensus proved to be one of the best trades of last year.

Although everyone is going to view this as a stupid trade, I am going to take solace in the fact that I am now very alone with this call.

I am shorting more JGBs into this quiet rise.

I don’t know what the catalyst is going to be, so don’t ask me that. I don’t know what is going to stop the steady rise as the BoJ buys every bond on the screen.

But I do know that shorting a 10 year bond that is yielding 57 basis points while inflation is running north of 2%, in the midst of one of the greatest global liquidity orgies of all time is a good risk reward.

I refuse to believe that QE programs are anything but bond negative. The Japanese are obviously testing my theory, but I think that if Abeconomics is successful, it will result in a much lower bond market.

The only way I see a long JGB position working from here is if the Japanese abandon their reflationary policies and revert to a quiet deflationary spiral lower (and even then I am not sure if long JGBs will work because they will eventually hit a budgetary impasses as their economy deflates).

The end game of a much lower Yen and higher inflation and rates for Japan has not changed. It is simply taking a little longer to play out than the hedge funds would like.

I love putting trades on when no one is interested. Shorting JGBs has become more attractive as prices have risen and hedge funds have moved on to the next exciting “must have” trade.

(For those who don’t want to trade JGB futures, have a look at JGBD which is a 3 times inverse ETN.)

Don’t forget that it wasn’t too long ago that the Japanese government was worried enough about selling JGBs that they created a whole campaign about how women love men who own JGBs.

http://themacrotourist.com/images/Azure/JGBAdJun2514.png

At which point guys started spoofing the ads coming up with stuff like this:

http://themacrotourist.com/images/Azure/JGBSpoofJun2514.png

At least I hope that is a spoof and not a real ad from the Japanese government. Little did I know that the best way to convincing a couple of women for a threesome was to take out a big long JGB position in physical form and cover my bed with the certificates. Somehow I don’t think that showing off my large JGB short futures position is going to have the same effect…

Oh well… I am going to worry more about finding lonely great risk reward trades like shorting more JGBs into this quiet rise instead of impressing the ladies. Could 10 year Japanese rates go to 40 or even 20 basis points? Sure. But could they also go to 200 or 400 basis points? Yes! Just because the hedge funds have gotten bored and moved on to the next trade is no reason for us to do the same…


Adding to my GDXJ trade

Yesterday we got a little bit of a reprise in the gold square. I took the opportunity to add to my GDXJ position.

http://themacrotourist.com/images/Azure/GDXJJun2514.pngGDXJ – Junior Gold Miners ETF</a> </div>

I have also been steadily adding to my CRK position.

http://themacrotourist.com/images/Azure/CRKJun2514.pngCRK – Crocodile Gold</a> </div>


Positions

http://themacrotourist.com/images/Azure/PositionsJun2514.png</p>