DPJ: Keeping the Bond Vigilantes at Bay     

• The rally in global equities remains intact, despite widely circulated rumors of its demise.  Japan's Nikkei 225 remains well supported above its 13-week and 26-week moving averages, despite the stiff headwinds of a surge in the JPY/USD rate to the JPY90/USD level, evidence that corporate profits remain depressed and concern that the Q2 "recovery" will fizzle.
• The bond vigilantes remain very leery of the new DPJ government’s "spend but do not tax" policies, and of its professed intention to wring out the pork in 50 years of LDP budgets. So far, however, this skepticism has not noticeably affected JGB yields, even though the Aso Administration bumped up JGB issuance in FY09 to JPY44 trillion from a Koizumi Administration "ceiling" of JPY30 trillion, and fears that this issuance could reach JPY50 trillion by FY2011.
• While 30-year TB prices in the US have plunged on soaring US deficits, Japan's longer dated 30-year JGB yields have trended between 2.75% and 2.00% since 2004, and even dropped to 1.7% at one point at the height of the global financial crisis. Shorter-dated 5-year JGB yields have plunged from 1.50% in '06 and '07 to a mere 0.60% on structurally weak domestic demand and re-accelerating deflation. With any recovery in Japan’s economy expected to be tepid, there appears to be no economic pressure for JGB rates to rise to the extent implied by bond vigilante bearish scenarios.
• The DPJ on paper can wring more than enough waste (pegged at some JPY20 trillion) from a plethora of special accounts to fund their spending promises. The real question for the would-be bond vigilantes is whether or not the DPJ has the political kahoonas to tame Japan’s bureaucrats.
• Banking regulators are particularly adept at closing the barn door AFTER all hell has broken loose and the thundering herd has stampeded. Stricter capital adequacy rules now under discussion could again put Japan's behind the eightball as regards capital adequacy. This has investors avoiding Japanese banks, even though the financial sector has been the best performing SPDR in the US over the past month and quarter, in favor of "dirty" non-ferrous and mining stocks who are seeing significantly higher commodity prices than originally assumed. 

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