• It's Here!

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

  • It's Coming...

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

Takeaway: Investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

SUMMARY BULLETS:

  • From our vantage point, the following three scenarios are all probable, with each ascending scenario being roughly twice as probable as the previous one on the list:
    1. The SEP and/or OCT US employment and inflation data cause the Fed to commence tapering in 4Q13;
    2. Abe’s Third Arrow platform (TBD) is well-received by the market and/or the BoJ preemptively eases monetary policy in 4Q13; or
    3. Abe’s Third Arrow platform is not well-received by the market and the BoJ refrains from preemptively easing monetary policy in 4Q13.
  • The unique nature of each of the aforementioned scenarios is supportive of developing consternation that may contribute to rising levels of implied volatility on the USD/JPY cross and in the Japanese equity market.
  • While we certainly don’t see the Abenomics Trade as being a rearview phenomenon, we do think the unsettled nature of the catalyst calendar is likely to breed contempt in the marketplace and contribute to a widening of the associated immediate-term trading ranges on a go-forward basis.
  • Thus, investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

THE 30,000 FOOT VIEW

With the recent announcement that the +300bps VAT hike will proceed as scheduled come APR ‘14 and the accompanying ¥5T stimulus package now in the rearview mirror, the policy calendar in Japan becomes relatively light again.

The general lack of clear policy catalysts from Japan is important in the context of the developing US monetary policy situation – specifically, the Fed’s recent decision not to taper asset purchases in spite of a clear acceleration in US growth data.

On the margin, the aforementioned FOMC surprise was a decidedly dovish maneuver that has weighed on the US dollar (now bearish TREND) vis-à-vis the Japanese yen (the USD/JPY cross is flirting w/ a TREND-line breakdown).

GET TIGHT AND TRADE THE RANGES IN JAPAN - 1

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 2

Quantitatively speaking, what’s bullish for the Japanese yen in almost perfectly bearish for Japanese equities; the trailing 1Y and 3Y correlation between the USD/JPY cross and the Nikkei 225 Index is +0.97, respectively.

GET TIGHT AND TRADE THE RANGES IN JAPAN - 3

Perhaps more importantly, the Nikkei 225 Index remains underwater vs. it’s late-MAY YTD high and is down -6.4% since the USD/JPY cross peaked on MAY 17. The more that currency cross remains under pressure due to FOMC dogma(s), the greater the probability that market participants start to walk away from the Japanese equity reflation side of the trade.

IN THE WEEDS

The aforementioned playbook is something to keep in mind as you attempt to manage risk around the next couple of US Jobs Reports and any headlines surrounding Prime Minster Abe’s Third Arrow over the next 2-3M.

Regarding that latter point, we think any policies designed to facilitate wage increases, spur corporate CapEx and/or convince Japanese companies to believe in the sustainability of the weak yen will be most impactful as it relates to FX market participants bidding up the USD/JPY cross on [good] news:

  1. Wage growth remains anemic in Japan with growth in monthly cash earnings slowing to -0.6% YoY in AUG; the trailing 1Y and 3Y average growth rate is -0.4% and -0.3%, respectively.
  2. Despite the 3Q13 Tankan Survey results accelerating to the highest levels in over 5Y, the one major disappointment of the survey was the large enterprises CapEx guidance forecast slowing to +5.1% from +5.5% prior. That forecasted rate of fixed investment growth is well off prior peaks of +10-12%.
  3. We believe the primary reason Japanese multinationals are still reluctant to invest in Japan’s future is because they are not yet convinced of the sustainability of the weak yen. Per the latest Tankan Survey, the NTM forecast of Japan’s large enterprises for the USD/JPY cross is a measly 93.77. A measured shift in the direction of our ~18M view of ~125 on that cross will be highly supportive of Japanese corporations reversing the secular trend of off-shoring production and unwinding entrenched deflation expectations that have perpetually weighted on wage growth in Japan. To the former point, Japan’s overseas auto production grew +3.6% YoY in AUG, which contrasts with the -8.1% YoY decline of domestic auto production (the 12th straight month of declines).

GET TIGHT AND TRADE THE RANGES IN JAPAN - 4

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 5

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 6

As we have forecast all along, Japan’s policy prescription has done little more than contribute to rising inflation expectations in Japan, thereby adversely widening the spread between those very expectations and expectations for economic growth. The following two data points highlight this bifurcation:

  1. Results from a Nikkei survey released today showed that there are roughly ~4x more companies that are considering passing along the VAT hike via price increases (fully = 48%; partially = 17.1%) than those that are considering pay increases in FY14 (bonus increase = 13%; wage increase = 2.4%; both = 8.1%).
  2. Results from the BoJ’s 3Q13 consumer survey showed that the number of Japanese households that anticipate inflation will accelerate over the NTM (83%, up from 80.2% prior) is roughly 5x greater than those that anticipate growth will accelerate over the NTM (16.2%, down from 24.3% prior).

Indeed, in the absence of near-term tapering out of the Federal Reserve (an event that we believe would be bullish for the USD/bearish for the yen/bullish for the Nikkei), the pressure upon the LDP to hit a home run with Abe’s Third Arrow program and/or upon the BoJ to preemptively ease monetary policy ahead of the APR ‘14 VAT hike in order to maintain faith in the market that it is appropriately progressing towards its +2% inflation mandate is great.

Regarding that latter point, SEP 19 commentary from BoJ Board Member Takahide Kiuchi highlights the heightening risk of the BoJ being forced by the market to reengage in the Currency War: “The Fed’s decision [to not taper] shows how hard it is to end unconventional monetary policy. Market expectations may push the BoJ to ease further.”

THE PORTFOLIO MANAGER’S PLAYBOOK

All told, for the time being, the “Abenomics Trade” (i.e. short the Japanese yen/long Japanese equities) no longer has the policy support of a #StrongDollar. That means Japanese policymakers will become increasingly important in determining the performance of the trade – a marked shift from the last 3-6M of US growth expectations largely determining the performance of the USD/JPY cross.

From our vantage point, the following three scenarios are all probable, with each ascending scenario being roughly twice as probable as the previous one on the list:

  1. The SEP and/or OCT US employment and inflation data cause the Fed to commence tapering in 4Q13;
  2. Abe’s Third Arrow platform (TBD) is well-received by the market and/or the BoJ preemptively eases monetary policy in 4Q13; or
  3. Abe’s Third Arrow platform is not well-received by the market and the BoJ refrains from preemptively easing monetary policy in 4Q13.

As an aside, we put emphasis on "preemptive" because, at the moment, both growth data and inflation expectations are supportive of the BoJ standing pat.

GET TIGHT AND TRADE THE RANGES IN JAPAN - 7

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 8

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 9

The unique nature of each of the aforementioned scenarios is supportive of developing consternation that may contribute to rising levels of implied volatility on the USD/JPY cross and in the Japanese equity market.

While we certainly don’t see the Abenomics Trade as being a rearview phenomenon, we do think the unsettled nature of the catalyst calendar is likely to breed contempt in the marketplace and contribute to a widening of the associated immediate-term trading ranges on a go-forward basis.

Thus, investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

Darius Dale

Senior Analyst