There’s a strange phenomenon that manifests itself rather frequently when one writes a column on financial markets. Often after writing a “how much worse can it get?” piece, one discovers a while later that the asset class in question has become one of the most attractive pieces of tradable financial wealth.
I realised the reappearance of this phenomenon only this evening, when looking back at a piece I wrote almost exactly a year ago about dollar/yen basis swap.
At that time, the introduction of negative interest rates had sent the basis to the widest ever historical level for swapping up those two currencies, and projections of further doom seemed appropriate.
In fact, “You never had it so bad” might have been a better headline, because the basis swap has become more and more benign ever since I penned that particular column.
Do I regret writing that column? Not at all. Back then, Abenomics was in its developing prime, the JGB curve was moving deeply negative and there was a buyer’s strike of gargantuan proportions.
Any investment that did occur a year ago emerged in the context of the big Japanese institutional investors reaffirming a half-forgotten rubric of investing on a 100-year time horizon – enough time to allow Elon Musk to build his human commune on Mars. And that was a smart way of burying the time value vicissitudes inherent in Abenomics and hoping that circumstances would magic the uncomfortable realities away.
The market did indeed do that, and I would proffer the theory that I caught the market at its most extreme.
HOW MUCH HAS changed in the meantime. Since those dark days, the Bank of Japan has contained some of the stress by targeting its JGB purchases towards fixing the 10-year benchmark around the 0% yield mark.
I cannot ascribe to the logic behind that theory, but one element of the market that seems poised to move again is the so-called Ninja loan market, wherein offshore borrowers raise syndicated debt onshore in Japan and enjoy the low coupons which accompany the trade, whether hedged or not.
On a hedged basis, the dollar/yen swap at five years has gone from the all-time low of minus 105bp, registered last March when I wrote my doom and gloom column, to a relatively benign -70bp. While hardly a bargain, if I were a major borrower able to price in size in the Ninja market I would be tempted to put the trade on – on a fully hedged basis.
And I would be more than tempted to lift that hedge on the assumption that the market will overshoot, that the basis will recover almost to zero within the context of a sharply depreciated yen, thanks to President Trump’s supposed policy of eliminating trade deficits via the exchange rate.
WHAT I FIND most fascinating about this potential arbitrage situation is that Japanese banks are beginning to show a rather radically different mindset than has applied over the past decade or so.
Cross-border loans offer Japanese banks the possibility of a decent net interest margin above and beyond what has been achievable for them in the domestic yen loan markets. And there appears to be a ready arbitrage opportunity in the Japanese market, given that counterparts to the dollar side of any swapped loan opportunity are willing to accept much lower margins to dollar Libor in booking assets.
Meanwhile if there is any accompanying aggression on the part of Japanese banks, in my book it is to be welcomed. We now hear stories of regional banks grumbling that the big Japanese universal banks are going out aggressively to win new loan business, only to sit on the eventuating paper rather than syndicating it out.
That must surely be the sign of a protracted – and supposedly intractable – situation turning around. Much the same thing is happening in Europe, where the European Central Bank is preparing to normalise policy after a few years of quantitative easing and negative rates. At the same time European banks are falling over themselves to book assets in the face of massive competition from other banks, and from compilers of collateralised loan obligations, where financing rates are at rock bottom and set to rise.
When I wrote about the dark days of the dollar/yen basis market I had no idea I was effectively calling a bottom to the market. For those people who care about such things I reckon it represented the start of a way back to normality. In Japan’s case, with its basket of demographic woes, it will never represent the return to the old normal; but the new normal will be a welcome change to what that country has endured for so long.
