REMEMBER, WE’RE IN THE VERY EARLY INNINGS OF ABENOMICS

Takeaway: We reiterate our long-term research conclusions for Japanese policy and its expected impact(s) upon various financial markets.

SUMMARY BULLETS:

  • On the heels of a clearly sanguine,  moderately hawkish FOMC presser today, the USD/JPY spot rate is now trading back above its TREND line of 96.17. Whether or not it holds there is a different story, but, assuming it is confirmed on a closing price basis, it would appear to us that the recent correction in that currency cross is over. If not, there’s no support to the TAIL line of 89.19.
  • With BOJ Governor Kuroda’s uneventful commentary overnight highlighting the very obvious fact that the BOJ could tighten or ease monetary policy depending on economic conditions and that the BOJ expects market volatility to subside over time, we are not inclined to deviate from the risk management conclusions we outlined in our latest note on Japan titled, “JAPAN STRATEGY UPDATE: IS THE ABENOMICS TRADE OVER?” (6/13).

 

All told, we reiterate our long-term research conclusions for Japanese monetary and fiscal policy, which are three-fold:

  1. While enthusiasm for the Abenomics agenda may come and go in the immediate-term, we believe investors are greatly underestimating the long-term impact of imposing – and ultimately working towards – a +2% inflation target and +3% nominal GDP growth target in Japan.
  2. No country in the history of the recorded universe has ever devalued its way to sustainable economic prosperity. While Japan’s case is fundamentally different than most – given entrenched deflation – we are inclined to side with the odds of history by suggesting that Japan’s Policies To Inflate will, if anything, result in inflation, not real GDP growth.
  3. The confluence of #1 and #2 will [continue to] prove decidedly negative for both the Japanese yen and the JGB market. In the context of intermittent spikes in bond market volatility, the risk-adjusted outlook for Japanese stocks appears a lot less rosy than one would assume given the reflationary tailwind of currency debasement. The caveat here is that this headwind can be offset – at least in part – by fiscal reforms (corporate tax cuts, labor market deregulation, etc.). This, of course, assumes that the Abe Cabinet will pursue these opportunities post July’s Upper House elections.

USD/JPY TREND BREAKOUT?

On the heels of a clearly sanguine,  moderately hawkish FOMC presser today, the USD/JPY spot rate is now trading back above its TREND line of 96.17. Whether or not it holds there is a different story, but, assuming it is confirmed on a closing price basis, it would appear to us that the recent correction in that currency cross is over. If not, there’s no support to the TAIL line of 89.19.

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With BOJ Governor Kuroda’s uneventful commentary overnight highlighting the very obvious fact that the BOJ could tighten or ease monetary policy depending on economic conditions and that the BOJ expects market volatility to subside over time, we are not inclined to deviate from the risk management conclusions we outlined in our latest note on Japan titled, “JAPAN STRATEGY UPDATE: IS THE ABENOMICS TRADE OVER?” (6/13). To recap that game plan:

  • “To the extent you have been short the yen or playing the Abenomics Trade in ancillary vehicles, it may prove prudent to sell/reduce your exposure upon confirmation (i.e. give it time to breathe) of a breakdown through the TREND line [on the USD/JPY spot rate].”
  • “The long-term TAIL line of support is down at [89.19]; that would be a good level to put the position back on/increase your exposure (as would a breakout back above the TREND line).”
  • “As one of our core research views, we remain the bears on the Japanese yen with respect to the long-term TAIL. We’re merely attempting to manage the immediate-to-potentially-intermediate-term risk of the position.”

INFLATION IS NOT [EXPORT] GROWTH

Elsewhere in Japan, export growth accelerated in MAY to +10.1% YoY from +3.8% prior. Hooray Abenomics? Not quite – Japan’s trade deficit widened to the fifth largest monthly reading ever on a seasonally-adjusted basis.

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Clearly Japan hasn’t experienced the export reflation/import substitution effect mainstream economists have been calling for amid yen debauchery.

Regarding the impact of yen devaluation on Japan’s BOP dynamics:

  • Commodities accounted for 49.1% of Japanese imports in 2012, up from 45% in 2010 (i.e. the last full year w/ nuclear power).  Imports of energy have increased to 34.1% of the total from 28.6% over that time frame. Incremental imports of commodities accounted for 94% of Japan’s trade balance deterioration in 2011 and 43% in 2012.
  • It will be interesting to see whether or not the weaker yen (down -17% YoY) starts to sustainably inflate exports, which re-price on a far greater lag than imports due to: A) preexisting FX hedges and B) the length of time between export orders, manufacturing production and actual shipments – which, of course, varies by industry. We have our doubts, especially given that 18.1% of Japanese exports go to China (largely in the form of capital equipment); we continue to have a very negative outlook for Chinese fixed assets investment – particularly with respect to the long-term TAIL duration.
  • Additionally, Japan also continues to experience tailwinds on the import front. While the weak JPY does indeed augment USD strength (which has been a headwind for commodity prices), the downside beta for the yen has outpaced the downside beta for commodity prices, meaning that the recent declines we’ve seen across the commodity complex have not been translated into import savings for Japan. In fact the opposite has occurred, as evidenced by the chart below which showcases the CRB Index priced in yen.

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CONCLUSIONS

All told, we reiterate our long-term research conclusions for Japanese monetary and fiscal policy, which are three-fold:

  1. While enthusiasm for the Abenomics agenda may come and go in the immediate-term, we believe investors are greatly underestimating the long-term impact of imposing – and ultimately working towards – a +2% inflation target and +3% nominal GDP growth target in Japan.
  2. No country in the history of the recorded universe has ever devalued its way to sustainable economic prosperity. While Japan’s case is fundamentally different than most – given entrenched deflation – we are inclined to side with the odds of history by suggesting that Japan’s Policies To Inflate will, if anything, result in inflation, not real GDP growth.
  3. The confluence of #1 and #2 will [continue to] prove decidedly negative for both the Japanese yen and the JGB market. In the context of intermittent spikes in bond market volatility, the risk-adjusted outlook for Japanese stocks appears a lot less rosy than one would assume given the reflationary tailwind of currency debasement. The caveat here is that this headwind can be offset – at least in part – by fiscal reforms (corporate tax cuts, labor market deregulation, etc.). This, of course, assumes that the Abe Cabinet will pursue these opportunities post July’s Upper House elections.

Best of luck out there continuing to navigate these immediate-term risks within the constructs of our/your intermediate-term and long-term views.

Darius Dale

Senior Analyst