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Doom Heralded at Hayman by Widening Trade Deficit: Japan Credit

October 22, 2012

Doom Heralded at Hayman by Widening Trade Deficit

Honda Motor Co. vehicles wait for shipment in front of a transporter ship in Yokohama City. Data yesterday showed Japan had its biggest half-year trade deficit on record. Photographer: Noriyuki Aida/Bloomberg

Japan’s worsening trade gap will make it harder to service the world’s largest debt, fulfilling part of the doomsday scenario that Hayman Capital Management LP is betting on.

The nation’s 10-year note yield may rise toward 10 percent from the world’s third-lowest of 0.79 percent, while the yen weakens, said Richard Howard, who oversees Dallas, Texas-based Hayman’s Japan-focused fund with J. Kyle Bass. That would represent the developed world’s second-highest borrowing costs after Greece, and a surge to that level by the end of 2013 would cause losses of 42 percent for investors purchasing the securities now, data compiled by Bloomberg show.

Data yesterday showed Japan had its biggest half-year trade deficit on record. Hayman, which manages about $1 billion, made $500 million by predicting the U.S. housing market collapse, and Bass has said since at least 2010 that Japan’s $12 trillion bond market is heading for a crash. So far, the debt has returned 3.1 percent in the past two years, Bank of America Merrill Lynch data show, while yields touched nine-year lows.

“It all came down to this idea that there was an internal self-funding mechanism in Japan, that essentially the Japanese economy and interest-rate environment could exist separate to the rest of the world,” Howard, 32, said in an Oct. 18 interview in Singapore. “It wasn’t going to last forever, and in fact it is rapidly approaching a turning point.”

Japan’s imports exceeded exports by 3.22 trillion yen ($40 billion) in the six months ended Sept. 30, the biggest trade deficit for a fiscal half-year period, according to Ministry of Finance data going back to 1979. The nation posted a shortfall in September for a third-consecutive month.

Current Account

The country has public debt equivalent to 237 percent of gross domestic product this year, the biggest debt-to-GDP ratio globally, estimates by the International Monetary Fund show. The ratio for the U.S. is 107 percent.

Ten-year Japanese government bond yields are less than half that of similar-maturity Treasuries and reached 0.72 percent in July, the least since June 2003. Japan’s current account, the broadest measure of trade, has been in the black on an annual basis since at least 1985, according to government figures, helping the country finance a budget deficit domestically for lower borrowing costs.

When Japan’s current account turns to deficit, “the marketplace is going to realize that it requires international capital, either repatriated Japanese capital or fresh new international capital, to buy Japanese government debt in order to keep funding the government,” said Howard. “That is the beginning of a cycle to put upward pressure on yields.”

RBC Samurais

On a monthly level, Japan reported a record deficit in its current account in January, showing the impact of rising energy imports following last year’s record earthquake that triggered the shuttering of nuclear plants.

Elsewhere in Japan’s credit markets, Kanagawa Prefecture plans to sell 20 billion yen of 20-year bonds next month, according to a statement yesterday by Daiwa Securities Group Inc., which will manage the offering with Mizuho Financial Group Inc.

Japanese municipal notes and the debt of government- affiliated organizations have handed investors a 0.02 percent loss this month as of yesterday, compared with a 0.08 percent decline for sovereign securities, according to Bank of America Merrill Lynch data. Global government bonds have also lost 0.17 percent in the period, the data show.

Royal Bank of Canada registered to sell as much as 600 billion yen of Samurai notes, according to a filing yesterday with Japan’s Ministry of Finance. Samurais are yen-denominated notes issued in Japan by overseas borrowers.

Yen Effect

The yen strengthened against most of its 16 major peers in the past six months as the euro region’s debt crisis boosted demand for the currency as a refuge. It touched 80.01 per dollar today, the weakest since July 6, before trading at 79.96 as of 9:51 a.m. in Tokyo, compared with its record high of 75.35 reached Oct. 31.

The stronger yen makes Japanese products costlier overseas and weighs on exports while encouraging domestic companies to acquire assets abroad. Softbank Corp., the country’s No. 3 mobile-phone career, agreed this month to buy a 70 percent stake in Kansas-based Sprint Nextel Corp. for $20.1 billion.

Proceeds from overseas investments have grown ninefold since 1985 through last year, helping alleviate a slump in exports. Japan had its first annual trade deficit last year in at least 27 years, Ministry of Finance data showed.

Household Wealth

Slower growth and more than a decade of deflation have prompted Japan’s banks to channel deposits into JGBs rather than loans. Domestic investors account for 91 percent of the total ownership of the nation’s debt, according to data from the Bank of Japan.

Japanese households held a total of 1,515 trillion yen of assets at the end of June, more than half of which were bank deposits, central bank figures showed. That’s bigger than the U.S.’s annual economic output in dollar terms and compares with 1,124 trillion yen of general Japanese government debt.

Standard & Poor’s said in a report yesterday that Japan’s deficits are likely to remain high for several years, and it runs the risk of a credit downgrade if its “debt trajectory were to remain on its current course.” S&P rates the sovereign AA- with a “negative” outlook.

The IMF said in its Fiscal Monitor report released this month that the Japanese government’s plan to double the 5 percent sales tax by 2015 won’t be sufficient to “put Japan’s record-high debt ratio on a downward path.”

‘Lot Higher’

A tumble in JGBs may happen in two steps, where a sell-off pushes yields a couple hundred basis points higher, triggering concerns about the government’s ability to refinance its debt, said Howard. That could push yields “a lot, lot higher” toward double digits, he said.

As to what may trigger the surge, “something very interesting” is likely to happen within the next 18 months, Howard said, declining to be more specific or to say how the fund is executing its Japan strategy. The risk to Hayman’s scenario is that concern about the rest of the world will sustain demand for Japanese assets as a haven, he said.

So far, financial markets are signaling little concern that Japan will fail to pay off its debts. The cost to insure JGBs against nonpayment for five years has fallen 67 basis points this year to 76 basis points yesterday, set for the biggest annual slide in data going back to 2005, according to CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

Investment Surplus

Tomoya Masanao, head of portfolio management for Japan at Pacific Investment Management Co., said on Oct. 10 that the nation’s debt is the “cleanest dirty shirt.” Pimco, which runs the world’s biggest bond fund, has been adding to its holdings of JGBs over the past two to three months, he said.

Ten-year JGB yields may hold in a range of 0.8 percent to 1 percent in the next 18 months, said Akio Kato, team leader for Japanese debt in Tokyo at Kokusai Asset Management Co. That compares with the five-year average of 1.2 percent.

“I don’t foresee a situation where the trade deficit offsets the investment surplus, driving the current account into the red,” said Kato, whose company runs Japan’s biggest mutual fund with $42 billion in assets. “It’s reasonable to assume that Japan’s bond market can still continue to retain investor confidence.”

To contact the reporter on this story: Masaki Kondo in Singapore at mkondo3@bloomberg.net

To contact the editor responsible for this story: Rocky Swift at rswift5@bloomberg.net


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