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Takeaway: Japanese policymakers continue to attack the yen, both rhetorically and with incremental POLICY maneuvers.

SUMMARY CONCLUSIONS:

  • In the week-to-date, Japan has certainly made a lot of noteworthy headlines – particularly on the POLICY front. In the note below, we highlight these recent developments with the intent of providing both historic context and future implications for Japanese and global financial markets.
  • Specifically, it is reasonable to anticipate that the pace of yen declines is likely to slow post the JAN 21-22 BOJ meeting, only to resume accelerated losses ahead of the changing of the guard atop the BOJ board in mid-to-late MAR (out with deputy governors Hirohide Yamaguchi and Kiyohiko Nishimura)/early-APR (out with Governor Shirakawa).
  • While we continue to view incremental monetary Policies To Inflate and expansionary fiscal POLICY as reflationary for Japanese equities and supportive of regional sentiment in the near term (Japan is the 2nd largest economy in Asia, where roughly two-thirds of all trade is intra-regional), over the long term we continue to see material risk of a Japanese currency and sovereign debt crisis borne out of those same policies.

NEW STIMULUS MEASURES

On Monday, it was reported that the Diet is preparing a ¥12 trillion supplementary budget for fiscal stimulus measures, with ¥5-6 trillion of that directed to public works projects. Additionally, the Finance Ministry will offer ¥100 billion of loans to help spur domestic R&D and an additional ¥70 billion fund to help Japanese companies finance overseas acquisitions.

Context & Implications:

  • As we outlined in our 12/26 note titled: “JAPAN TO LOOSEN FISCAL POLICY AS WELL”, Japan’s fiscal POLICY outlook is deteriorating rapidly as PM Shinzo Abe seeks to reflate the Japanese economy to capture more political goodwill for his LDP party ahead of the late-JUL Upper House elections.
  • This ¥12 trillion supplementary budget figure is in line with our estimates of > ¥10 trillion and will likely require ¥8-10 trillion in deficit-financing bond issuance, according to market chatter. That’s ok, though: Finance Minister Taro Aso reiterated his pledge to blow right through the ¥44 trillion debt issuance ceiling in the upcoming fiscal year. Piling debt upon debt upon debt will only accelerate Japan’s jumping of the ¥1 QUADRILLION debt outstanding shark.
  • That being said, however, we continue to anticipate Policies To Inflate to continue to drive the yen lower and Japanese equities higher over the intermediate term – at least until the bond market starts to price in a sustained phase change with regards to Japan’s INFLATION dynamics.
  • For more details on how we think Japan’s Keynesian experiment could end in a globally-destabilizing Japanese sovereign debt crisis, please refer to the following two notes:

BUYING ESM DEBT

On Tuesday, it was reported that Japan is planning to use its FX reserves to buy European Stability Mechanism debt to “help weaken the yen”, according the Finance Minister Taro Aso.

Context & Implications:

  • Japan, which has $1.2 trillion in FX reserves, has already purchased $9.2 billion of EFSF debt (6.7% of total issuance), so this pledge does little to move Japan in the direction of a bonnafide foreign asset purchase program.
  • Not to mention, because they are using FX reserves to make the purchases, it’s unlikely that this initiative alone will result in material weakness in the yen over the intermediate term. In fact, the only way ramping up allocations to ESM debt would systematically and sustainably weaken the yen is if Japanese policymakers instead used JPY-denominated domestic capital to make the purchases.
  • In light of this somewhat disappointing news, we are not surprised to the see the yen bounce ever-so-slightly from oversold levels in the week-to-date.
  • That said, however, we continue to anticipate that the BOJ will ultimately be forced to print yen to buy foreign currency-denominated assets; that’s what the market wants and is sniffing out.
  • From a timing perspective, that catalyst is likely several months away – likely after Shirakawa and his two deputy governors are replaced at the BOJ in mid-to-late APR.

REVIVING THE COUNCIL ON ECONOMIC AND FISCAL POLICY

Today, it was reported that the Council on Economic and Fiscal Policy will meet for the first time in four years. Previously abolished by the outgoing DPJ government – which tends to favor increased central bank independence and fiscal sobriety (i.e. they shun direct financing of public expenditures by the BOJ), on the margin – the Council on Economic and Fiscal Policy meetings will once again pool together Cabinet members (including Prime Minster Shinzo Abe), academics, business leaders and BOJ board members in a broad-based discussion of Japan’s POLICY objectives.  

Context & Implications:

  • Who needs to revise the 1998 BOJ Act – which created the BOJ’s independent POLICY-setting board – when one could just meet regularly to ensure the central bank’s POLICY objectives are aligned with those of the Diet leadership?
  • As such, we see limited risk for any legislative threat to BOJ independence with respect to the immediate-to-intermediate term. It should be much easier for Abe & Aso to exert political pressure upon the BOJ board in face-to-face meetings than it would be through political grandstanding, as they have been doing in recent months.
  • That being said, if the BOJ doesn’t revise its inflation target up to +2% at the JAN 21-22 meeting and introduce further easing measures (its current Asset Purchase Program and Lending Program total ¥101 trillion), we could see Abe throw down the gauntlet from a rhetorical perspective.
  • To the extent BOJ Governor Masaaki Shirakawa still believes a joint BOJ-Diet INFLATION target (de facto or de jure; the net result is the same) is not a good thing, he could be met halfway by adopting the aforementioned +2% INFLATION target while simultaneously instituting an indefinite timeframe with regards to achieving the goal.
  • Focusing on the markets, assuming some confluence of what we outlined above materializes in the coming weeks, it will be tough to see declines in the yen accelerate (i.e. break through the mid-to-low 90’s vs. the USD; break through the mid-to-low 120’s vs. the EUR) in the late-JAN through mid-MAR period on the strength of just fiscal POLICY and jawboning alone.
  • While we don’t necessarily view the following risk as probable at the current juncture, you could see the JPY pull back towards our TAIL line of ¥83.94 per USD before resuming further declines to lower-lows – particularly if we get any US Debt Ceiling-induced bout of global risk aversion.
  • What should really get Japan’s currency revved up again to the downside is the pending discussion of who’s going to replace Shirakawa and his two deputy governors atop the BOJ board. Judging by the last two appointees (Takahide Kiuchi and Takehiro Sato joined the board in mid-2012), the candidates will likely be of the view that the central bank needs to play a larger role in overcoming persistent deflation.
  • By contrast, Shirakawa has long held the view that the BOJ cannot achieve its inflation target on its own. At a business conference in JAN ‘10, he remarked: “A lack of demand was the root cause of deflation and there was no magic wand [to overcome it].”
  • If former BOJ deputy governor Kazumasa Iwata is indeed a legitimate candidate to succeed Shirakawa, he would be especially in favor of a foreign asset purchase program; he suggested in a JAN ‘12 interview that the finance minister should let the central bank create a ¥50 trillion (then $643 billion) bond-buying fund to combat the yen’s gains.
  • Toshiro Muto and Heizo Takenaka are also being rumored as candidates for the BOJ governorship in the early goings and both are also in favor of structurally more aggressive action out of the BOJ – which is exactly what we have been calling for since we outlined our bearish TREND and TAIL bias on the yen back on SEP 27 (“IDEA ALERT: SHORTING THE YEN AS SINO-JAPANESE TENSIONS ESCALATE”).

CONTEXT AROUND RECENT POLICY DEVELOPMENTS IN JAPAN - 1

Darius Dale

Senior Analyst