Japan: Enter the Funding Crisis

Can you picture what will be
So limitless and free
Desperately in need of some stranger's hand
In a desperate land
--The Doors

Fleck thinks that we are witnessing an important juncture in financial history. We are seeing, or perhaps have just seen, the end of the environment that finds people believing that central banks can create financial nirvana via quantitative easing, or money printing.

While his is not a unique thesis, Fleck has presented his case clearly. He has long argued that we will never see an end to zero interest rate policy (ZIRP) until we have a funding crisis--meaning that creditors refuse to buy more sovereign bonds at uber low, manipulated interest rates. He has said that the funding crisis would begin when one of the big sovereign debt markets begins to crack.

Fleck thinks that this has begun...in Japan. A couple of days ago yields on long term Japanese government bonds (JGBs) traded thru 1%. This may not sound like much, but it is roughly 3x the yield corresponding to the initiation of Japan-style QE by the Bank of Japan a couple month's back. Imagine rates on 10 yr Treasuries exploding from 2% to 6% in a few days.

Following the move thru 1% by JGBs on Thursday, the Nikkei rallied more than 1%, and then flipped over and closed more than 7% lower.

One mechanism for big-time selling is that higher yields raise borrowing costs and crush carry traders, who must sell risky assets in order to delever.

Fleck likens this move in Japan to early funding problems in the mortgage market in 2007 (New Century Financial, anyone?) where the worst credit gets hit first. It is now a matter of time for realization of a systemic problem to spread in contagion-like fashion.

What comes next is reaffirmation from central bankers of their commitment to 'all in' liqudity (i.e., massive money printing). If markets don't stabilize after than jawboning, then it is comeuppance time for stocks.

position SPX, Treasuries