For the longest time I was short Japanese government bonds. I liked to laugh that eventually when the trading gods called for me, I would hand down to my kids my most treasured possessions, and… a short position in JGB futures.
Yet last month when the Japanese government pegged the 10 year yield at 0%, I felt there were better bonds to shoot against, so I reluctantly covered my position. Eventually the JGBs will be a terrific short, but pegs can be held for a long time before they crack.
It’s ironic that mere weeks after the Bank of Japan decided to peg their 10 year yield, the global bond bear market finally arrived. Whereas last month Central Banks were worried about long term yields slipping below zero, suddenly bond markets throughout the world have collapsed and yields are skidding upwards. Even though this environment should have ushered in the long awaited Japanese government bond decline, the BoJ stole that joy from the JGB bears.
There is no bigger JGB bear than one of my favourite hedge fund managers - Crispin Odey. I like to give hedge fund managers grief for chasing fads and not being willing to fade consensus, yet none of those complaints can be directed Crispin’s way. I don’t know how he manages to keep his assets under management, but he has somehow developed a loyal following that will sit through his wild swings. And I mean wild. Have a look at his year to date performance:
Down 40% would put most hedge funds out of business, but not Odey. He is the last breed of old school hedge fund managers who put up some extremely volatile returns. Far from criticizing his decline, I like to celebrate it. If I had to go work for a hedge fund, Odey Asset Management would be the top of my list.
Have a look at the size of Crispin’s positions. I could only find this summer’s report, but look at the notional exposure:
Odey has 86% of his fund in gold! And then he has a long Australian bond versus short Japanese 10 year position that accounts for 36% of his portfolio.
For a while being long Australian bonds versus short JGBs was pure genius. Australian 10 years were yielding over 250 basis points over JGBs, which made the trade positive carry, and as the deflationary global gloom spread over markets, Australian bonds rocketed higher as their yield plunged.
Now that this tide has turned, Australian bonds have reversed lower, but JGBs are pegged to 0%.
I don’t know if Crispin has taken off his position or not. Given his stubborn nature, my suspicion is that he is still lugging it around, but that’s pure speculation on my part.
This position should eventually work, but it’s probably going to have a few quarters of pain first. Assuming we have entered a global bond bear market (which is now the overwhelming consensus), then Australian yields will drift higher, and Japanese government bonds will be pegged to zero. To keep 10 year JGBs from declining, the Bank of Japan will be forced to buy bonds. The greater the bear market, the more bonds they will buy.
When the BoJ buys bonds, the money supply will expand, so the Yen will decline. It’s no surprise the Yen has been following the US 10 year yield almost tick for tick during the past few weeks:
I don’t have any great insight regarding JGBs except to note the following; if the global bond bear market accelerates, there will be tremendous pressure on the Bank of Japan. They could be forced to print an uncomfortable amount of Yen to maintain the peg. This peg won’t break quickly, but as the money printing adds up and the Yen plummets, eventually the Bank of Japan will be forced to allow the 10 year JGB yield to rise. This repricing will be swift and ugly.
So I am watching Odey’s long Australian bonds short JGBs with great interest. I fully expect to join my favourite madman in that trade in the coming months. After all, Crispin is down 40% and I have great faith he will be back in the black in no time. I have learned not to fade that nutbar, especially when he is down.
I felt a little lonely with yesterday’s post about covering my bond short and putting out a small stock short. And so far, I am looking like a little bit of a heel. Yet I took a small amount of solace from DoubleLine’s Gundlach’s comments yesterday:
Then my spirits were lifted by an FT article that trotted out the biggest bond bear from the 1970s.
Haven’t heard from the original Dr. Doom in three decades, so the fact that he is now getting airtime is definitely encouraging for those bond bulls.
And finally, for all those newly minted stock market bulls, Bloomberg’s Joe Weisenthal posted a terrific chart that outlined the huge divergence between financial conditions and the S&P:
I am still lonely with my bond cover and the small stock market short initiation, but I am feeling better about it every hour…
Thanks for reading,
Kevin Muir the MacroTourist