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Takeaway: On balance, this weekend’s data is unsupportive of our bullish bias on Chinese equities and very supportive of our bearish bias on the yen.

SUMMARY CONCLUSIONS:

  • China: Over the weekend, China put up some particularly soft FEB growth figures. If there is, however, one positive to take from these data points, it’s that they should meaningfully slow the proliferation of monetary tightening speculation, which had been weighing on Chinese equities over the past few weeks (1Y OIS 25bps premium to benchmark HH Savings Deposit Rate; up +12bps MoM).
  • Bearish from an immediate-term TRADE perspective and bullish from an intermediate-term TREND and long-term TAIL perspective, the Chinese equity market is currently signaling to us exactly what the fundamental data suggests: near-term weakness that should ultimately give way to intermediate-to-long-term upside. As such, we continue to have conviction in our Asian #GrowthStabilizing theme (long China, Hong Kong and Singapore).
  • Japan: Through an aggressive mix of fiscal and monetary policy, Japanese officials have managed to burn Japan’s currency by nearly -20% (-19.3% to be exact) since we started shorting it back on SEP 27. Japan has literally crashed its currency and still continues to see weakness across some key economic growth statistics – largely underpinned anemic demand for capital goods, etc.
  • Consensus among sell side analysts and multinational corporations is still not even in the area code of being bearish enough on the yen – particularly relative to our expectations of a true phase change across the BOJ leadership. In this light, the buy side remains underexposed to yen downside as well.
  • At a time when investors are broadly beginning to consider the merits of pulling forward expectations of Fed “tightening” (i.e. ending its open-ended asset purchase program), Japan’s intermediate-term policy outlook should continue to weigh heavily on the yen.
  • That outlook is decidedly dovish – especially with Haruhiko Kuroda taking over the BOJ leadership reins from Masaaki Shirakawa. The two gentlemen are indeed polar opposites when it comes to monetary policy and willingness to ease, with the former being much, much more aggressive than the latter. For example, Kuroda was out this weekend suggesting that the central bank's new +2% inflation target can be achieved by utilizing monetary policy alone – a view the outgoing Shirakawa strongly disagrees with.
  • Abe will no doubt want to maintain the current high level of popular support for himself and his LDP platform (75.8% approval rating) through the late-JUL Upper House elections, where we expect the LDP to increasingly position themselves to earn a slight majority – giving them control over both houses of Japanese parliament and free reign to pursue a much broader swath of currency-negative fiscal and monetary policies. As such, we continue to anticipate both he and Taro Aso will continue to lean heavily upon the eventually-politicized BOJ board to “do more” in the weeks and months to come.

***The note below is a follow-up to our 2/27 Best Ideas presentation, where we provided to clients detailed outlines of our bullish bias on Chinese stocks and our bearish bias on the Japanese yen. To the extent you may have missed that call, please use the following links to access the associated materials:

CHINA STUMBLES

Over the weekend, China put up some particularly soft FEB growth figures:

  • JAN-FEB Industrial Production: 9.9% YoY from 10% in DEC vs. 10.6% Bloomberg consensus estimate
  • JAN-FEB Fixed Assets Investment: 21.2% YoY from 20.6% in DEC vs. 20.7% Bloomberg consensus estimate
  • JAN-FEB Retail Sales: 12.3% YoY from 14.3% in DEC vs. 15% Bloomberg consensus estimate
  • FEB CNY New Loans: 620B from. 1070B in JAN vs. 700B Bloomberg consensus estimate
  • FEB CNY Aggregate Financing: 1070B from 2540B in JAN vs. 1500B Bloomberg consensus estimate
  • FEB M2 Money Supply: 15.2% YoY from 15.9% in JAN vs. 15.9% YoY Bloomberg consensus estimate

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 1

 

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 2

 

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 3

 

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 4

 

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 5

As you would imagine, these data points are not at all a great handoff for anything that would eventually resemble a Chinese #GrowthAccelerating bull case. If there is, however, one positive to take from these weak growth figures, it’s that they should meaningfully slow the proliferation of monetary tightening speculation, which had been weighing on Chinese equities over the past few weeks (1Y OIS 25bps premium to benchmark HH Savings Deposit Rate; up +12bps MoM).

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 6

That being said, however, the hawkish FEB CPI print (Headline: 3.2% YoY from 2% in JAN vs. 3% consensus; Food: 6% YoY from 2.9%; and Non-Food: 1.9% YoY from 1.6%) may indeed limit that proposed tailwind and we need to continue to see the disinflationary impact of Strong Dollar = Strong Yuan to remain positive on the Chinese economy and China’s equity market with respect to the intermediate term. For more details on the impact of USD strength on select Asian economies, please refer to our FEB 27 note titled: “HONG KONG STILL LOOKS AWESOME”.

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 7

We also remain positive on China’s structural reform outlook as the Chinese Communist Party brass attempts to wean the Chinese economy away from an overreliance on fixed investment (“I”/GDP of ~50% is ~1,000bps too high). The latest news on this front is that the State Council plans an increase in the minimum wage to 40% of average urban salaries by 2015. That too should help underpin Chinese consumer demand and mitigate any tail risk of a destabilizing collapse in prices across the Chinese real estate market(s).

Bearish from an immediate-term TRADE perspective and bullish from an intermediate-term TREND and long-term TAIL perspective, the Chinese equity market is currently signaling to us exactly what the fundamental data suggests: near-term weakness that should ultimately give way to intermediate-to-long-term upside. As such, we continue to have conviction in our Asian #GrowthStabilizing theme (long China, Hong Kong and Singapore).

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 8

KURODA ADOPTS DRAGHI’S “WHATEVER IT TAKES” FORMAT

This weekend, weak JAN-FEB Japanese growth figures augmented our cyclical bear case for the JPY: JAN Machine Orders: -9.7% YoY from -3.4%; -13.1% MoM from 2.8%; and FEB Machine Tool Orders: -21.5% YoY from -26.4%.

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 9

Through an aggressive mix of fiscal and monetary policy, Japanese officials have managed to burn Japan’s currency by nearly -20% (-19.3% to be exact) since we started shorting it back on SEP 27. Japan has literally crashed its currency and still continues to see weakness across some key economic growth statistics – largely underpinned anemic demand for capital goods, etc.

To some degree, the lack of reflation among said growth figures in spite of aggressive currency debasement can be attributed to the fact that the overwhelming majority of multinational corporations (i.e. some of the largest actors in the forex markets) simply do not trust what they are seeing in the currency markets. The latest Cabinet Office survey showed that Japanese exporters expect the USD/JPY rate to be at 88.40 in one year’s time (USD/JPY at ~93 at the time of survey); that compares to a forecast of 80.3 one year ago (USD/JPY at ~81 at the time of survey).

This latest projection of yen strength is quite aggressive even relative to the Bloomberg consensus estimate of 96 yen per dollar at end-of 1Q14.  

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 10

Clearly the key takeaway here is that consensus is not bearish enough on the yen – particularly relative to our expectations of a true phase change across the BOJ leadership. In this light, the buy side remains underexposed to yen downside as well:

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 11

In fact, the only people who seem to agree with us that the USD/JPY cross is poised to return to pre-crisis levels of ~125 over the long-term are foreign equity investors, who have been net buyers of Japanese equities every week since the week-ended NOV 16 (the Nikkei 225 Index is up +36.8% since then). If we wind up being wrong on our call for demonstrable yen weakness from here, then shorting Japanese equities will eventually become one of the best Global Macro trades in recent memory.

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 12

 

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 13

That is, however, not our base case scenario – especially not with Haruhiko Kuroda taking over the BOJ leadership reins from Masaaki Shirakawa. The two gentlemen are indeed polar opposites when it comes to monetary policy and willingness to ease, with the former being much, much more aggressive than the latter. For example, Kuroda was out this weekend suggesting that the central bank's new +2% inflation target can be achieved by utilizing monetary policy alone – a view the outgoing Shirakawa strongly disagrees with.

Kuroda added that he would like to quickly debate and decide on specific monetary easing measures, though he declined to provide many details. He did, however, reiterate that the BOJ needs to take bolder steps, both in terms of "quantity and quality", including increasing the duration risk of the central bank’s JGB purchases.

Kuroda also said that the BOJ has not been buying enough assets to meet its +2% inflation target and that, if appointed, he would do “whatever it takes” to achieve this goal. Recall that Kuroda has also called for speeding up the introduction of the central bank's open-ended asset purchases, which are not currently scheduled to begin until JAN ’14.

All told, Japanese officials want them some inflation and Abenomics will continue to edge Japan towards that outcome if the following is their base case scenario:

“Japan was unlikely to suffer from hyperinflation due to its aggressive monetary and fiscal stimulus measures.”

-Prime Minister Shinzo Abe, MAR ‘13

Abe would certainly not be Japan’s first bureaucrat to jump the [policy] shark in pursuit of inflation. Recall Japan’s Great Depression-era experiment that mandated the BOJ to directly monetize Japanese sovereign debt (as opposed to open-market operations), which began in 1932 and continued for the next 14 years.

During this era, the ratio of JGB issuance financed directly by the BOJ peaked at 89.6% in 1933 and remained elevated throughout the program. This monetization strategy assisted in doubling JGB issuance and boosting Japanese public expenditures by a whopping +34% in 1932 alone. Japanese CPI readings peaked at rates north of +40% YoY throughout the 1930s during the aforementioned episode of aggressive sovereign debt monetization.

BEST IDEAS UPDATE: LONG CHINA; SHORT YEN - 14

For now, however, the Japanese populace remains much like frogs being boiled in water; Abe does indeed enjoy broad support, with his approval rating at 75.8% per Tokyo Broadcasting System (unchanged MoM) – good for the highest popularity of any Japanese prime minster since Junichiro Koizumi in 2006.

Abe will no doubt want to maintain this level of support for himself and his LDP platform through the late-JUL Upper House elections, where we expect the LDP to increasingly position themselves to earn a slight majority – giving them control over both houses of Japanese parliament and free reign to pursue a much broader swath of currency-negative fiscal and monetary policies. As such, we continue to anticipate both he and Taro Aso will continue to lean heavily upon the eventually-politicized BOJ board to “do more” in the weeks and months to come.

At a time when investors are broadly beginning to consider the merits of pulling forward expectations of Fed “tightening” (i.e. ending its open-ended asset purchase program), Japan’s intermediate-term policy outlook should continue to weigh heavily on the yen.

Darius Dale

Senior Analyst