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Takeaway: If you’re bearish on US growth, get long the yen and short the Nikkei with impunity. Do the opposite if you’re constructive on US growth.

This note was originally published June 05, 2013 at 13:28 in Macro

SUMMARY BULLETS:

  • The "Third Arrow" of Shinzo Abe's "Abenomics" agenda wildly disappointed investor expectations. We detail those disappointments and a widely-misunderstood critical policy delta in the first part of the note below.
  • Increasingly, it appears that we remain among the few firms left with an explicitly bullish outlook for US economic growth and we’ll maintain that view until our leading indicators tell us reverse course. For now at least, 10Y bond yields (bullish TREND & TAIL), the SPX (bullish TREND & TAIL), the DXY (bullish TREND & TAIL), Gold (bearish TREND & TAIL) and Oil (bearish TREND & TAIL) all continue to state that the positive trend in US economic growth remains intact. The recent ISM data definitely sounds the alarm bells, but determining if there is an actual fire to put out requires more than one month of data.
  • As such, we continue to be inclined to short the yen and buy the dollar with respect to the intermediate-term TREND. As the USD/JPY cross nears the low end of our immediate-term risk range, we think now is a good spot to add to positions or put the full trade back on to the extent you have previously booked gains.
  • While we are certainly not ones to catch falling knives, we do think this is as good of a buying opportunity in Japanese equities as “investors” have gotten since we were calling for Japanese equity reflation last NOV – especially in the context of our base case scenario of 110 and 125 on the USD/JPY cross by EOY ’13 and EOY ’14, respectively.
  • That is, of course, if the Nikkei 225 Index’s TREND line (under major duress as of the latest close) holds. If the breakdown is confirmed, however, expect us to start sending you “shorting Japanese equities” trade alerts in the near future.
  • All told, if you’re bearish on US growth from here, get long the yen and short the Nikkei with impunity. If, however, you’re constructive on US growth from here – like us – do just the opposite. Don’t make this policy-induced gong show any more complicated than that.

"THIRD ARROW" OR "FIRST RODEO"? 

Today, Japanese Prime Minster Shinzo Abe unveiled the “Third Arrow” of his Abenomics agenda, which mostly consisted of a series of grand targets for various economic measures with little-to-no details for how to achieve them:

  • Promote a +¥1.5M increase in gross national income per capita over 10 years – implying a CAGR of +3.4%;
  • Increase capital spending by +10% to ¥70T over the next three years;
  • Deregulate the energy, health and infrastructure sectors;
  • Boost power-related investment +150% to ¥30T;
  • Set up special economic zones in Tokyo and other large cities to attract foreign investment;
  • Double FDI to ¥35T by 2020;
  • Double exports from small and medium-sized companies by 2020;
  • Double farm exports by 2020;
  • Triple infrastructure exports, such as bullet trains and nuclear plants, to ¥30T; and
  • Have 70% of all exports covered by free trade deals – including the Trans-Pacific Economic Partnership – by 2018 (up from 19% now).

Taken in their entirety, these goals are designed to perpetuate an average of +3% nominal GDP growth and +2% real GDP growth over the next decade. Also worth noting is the disappointing lack of targets for reforming Japan’s public pension allocation and lowering corporate taxes, which, at 37%, are the second highest in the OECD.

It goes without saying that there’s a lot of politicized junk food to sift through from Abe’s speech today, but the updated GDP targets were by far the most important takeaway as it relates to Japanese and globally-interconnected financial market risk. If these nominal and real GDP targets are, in fact, accurate, this inherently takes down the LDP’s former +2% inflation target to +1%. Ultimately, this implies that the BOJ doesn’t have to be as aggressive in pursuing its monetary easing agenda.

SHORT THE YEN, BUY THE NIKKEI? - dari

It is rather unclear to us how Abe & Co. plan to adhere to a potentially lower inflation target in the context of what would be an unprecedented string of wage growth with respect to the post-bubble Japanese economy. More clarity in needed as it relates to whether or not the CPI target has truly been revised down -100bps to +1%; we’ll learn for sure by the end of next week (ether during the upcoming “Third Arrow” ratification process that is scheduled to take place JUN 12-14 in the Diet or at the BOJ’s JUN 11 board meeting).

THE ABENOMICS TRADE: WHERE TO FROM HERE?

All in, the JPY is up +3.8% vs. the USD since MAY 22, which compares to about +1.7% for the EUR (likely dragged up on a correlation-weighted basis). Going back to our 5/10 note titled: “TRADING ABENOMICS FROM HERE”, the sustainability of the Abenomics trade we authored (short yen; long Japanese equity reflation) has become primarily a function of the slope of US economic growth expectations and not a function of Japanese policy as it had been prior to then.

The only meaningful Japanese catalyst left is the JUL Upper House elections, but even that is turning out to be less of a catalyst as its outcome becomes increasingly obvious: per a recent Nikkei Newspaper poll, almost half of voters planned to vote for the LDP, compared with 6% for the next largest party (DPJ). An LDP majority would give Abe & Co. free reign to delay fiscal reform to the extent they aren’t getting the results they are currently hoping for on the GDP growth front several quarters from now. Recall that outgoing Prime Minster Yoshihiko Noda of the DPJ staked his political career and his Party’s fate on passing the VAT hike legislation.

On the flip side, the only probable catalysts we see that could derail the Abenomics trade are likely to continue coming from Japan at this point – much akin to today’s disappointing “Third Arrow” speech and Friday’s news that Japan’s FSA tightened rules on forex margin trading, which were designed to “protect investors” and “limit speculation”.

Needless to say, the latest US mini-growth scare we’ve experienced over the past 2-3 weeks has weighed on the USD. Ironically, to us at least, the scare is being perpetuated by rising interest rates – which have historically signaled an acceleration in the trend growth rate(s) of US GDP. Consensus has become so hooked on financial repression that investors are broadly missing what may wind up being the most obvious economic signal in recent memory.

SHORT THE YEN, BUY THE NIKKEI? - 2

Increasingly, it appears that we remain among the few firms left with an explicitly bullish outlook for US economic growth and we’ll maintain that view until our leading indicators tell us reverse course. For now at least, 10Y bond yields (bullish TREND & TAIL), the SPX (bullish TREND & TAIL), the DXY (bullish TREND & TAIL), Gold (bearish TREND & TAIL) and Oil (bearish TREND & TAIL) all continue to state that the positive trend in US economic growth remains intact. The recent ISM data definitely sounds the alarm bells, but determining if there is an actual fire to put out requires more than one month of data.

SHORT THE YEN, BUY THE NIKKEI? - UST 10Y

 

SHORT THE YEN, BUY THE NIKKEI? - SPX

 

SHORT THE YEN, BUY THE NIKKEI? - DXY

 

SHORT THE YEN, BUY THE NIKKEI? - GOLD

 

SHORT THE YEN, BUY THE NIKKEI? - OIL

 

SHORT THE YEN, BUY THE NIKKEI? - ISM Manfuacturing   Services

As such, we continue to be inclined to short the yen and buy the dollar with respect to the intermediate-term TREND. As the USD/JPY cross nears the low end of our immediate-term risk range, we think now is a good spot to add to positions or put the full trade back on to the extent you have previously booked gains.

SHORT THE YEN, BUY THE NIKKEI? - USDJPY

Indeed, the Abenomics trade has experienced a fairly meaningful correction in recent weeks (the Nikkei 225 is down -16.7% from its 5/22 YTD peak; the USD/JPY cross is down -3.8% from its 5/17 YTD peak); on the heels of this demonstrable pullback, the Nikkei 225 Index is now broken TRADE and TREND on our quantitative risk management score.

While we are certainly not ones to catch falling knives, we do think this is as good of a buying opportunity in Japanese equities as “investors” have gotten since we were calling for Japanese equity reflation last NOV – especially in the context of our base case scenario of 110 and 125 on the USD/JPY cross by EOY ’13 and EOY ’14, respectively. That is, of course, if the Nikkei 225 Index’s TREND line (under major duress as of the latest close) holds. If the breakdown is confirmed, however, expect us to start sending you “shorting Japanese equities” trade alerts in the near future.

SHORT THE YEN, BUY THE NIKKEI? - 10

All told, if you’re bearish on US growth from here, get long the yen and short the Nikkei with impunity. If, however, you’re constructive on US growth from here – like us – do just the opposite. Don’t make this policy-induced gong show any more complicated than that.

Darius Dale

Senior Analyst