Japan Rallies while Western Markets fall on Sovereign Debt

The Americans and their allies were moving to reduce the intensity of  air strikes in Libya now that the Colonel`s defenses have been mauled, and optimism with respect to Japan`s fortunes in dealing with the nuclear crisis was improving as well, but ironically markets have reacted to the news with sales today. Technical analysis experts, including Laszlo Birinyi, were predicting a fall of around 10% for the entire correction, but even if that were to happen, it will still be a brief reversal in what is essentially an central bank inflated global asset market.

Today`s sales were attributed to the 90-odd bps rise in Irish 2-yr yields, and since Asian markets were doing reasonably well with Japan in a bullish mood after yesterday`s holiday, this explanation seems to make sense. And if we consider how resilient the market has been to what could have been a period of severe pummeling, after a number of massive negative surprises, a little bit of selling should come as no surprise. We believe that stock and commodity markets will continue to remain in a bullish trend for as long as the Fed maintains its easing bias. As such, while the oil shock and the Japanese earthquake are powerful enough to derail any trend in the short-term, the printing press will rule in the longer term.

The main question is whether the Fed will be inclined to raise interest rates at any point as a consequence of the events that we are focusing on at the moment, in part due to emotional reasons. There is little sign that the bank will see the recent fluctuations as an indication of a shift in long-term, multi-year inflation expectations, on the notion that the Libya War as well as the Japanese Earthquake are all one-time events that will not have lasting influence on pricing power or consumption trends. To reinforce this viewpoint, we have some signs that the Japanese people will be even more conservative in their spending habits – a phenomenon that might at best be compensated for by increased government expenditure. Only a sustained bull market in the country would challenge this analysis, but Japan has no grounds to fuel such a trend, outside of the external dynamics generated by global economic growth. It therefore makes sense to expect both the BoJ and the Fed to maintain their present postures.

It is clear that the Asian and Western markets cannot remain decoupled from each other for a long period of time, and if the concerns about Europe intensify there is a good chance that we could see the weakness spread around the world to last till the end of this week. But given how big the incentive is for Europe to avert a breakdown of the E.U., after so much money spent and committed in the past year alone, we believe that the first half of 2011 will be a bullish phase, overall, for the world of finance.

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