#GROWTHDIVERGENCES: ALL EYES ON JAPAN

Takeaway: While our conviction over the next 3-6M is unlikely to be anywhere near where it has been, we think it pays to #BTDB in the Abenomics Trade.

CONCLUSIONS:

  1. We remain bearish on the Japanese yen and bullish on Japanese equities with respect to the intermediate-term TREND and long-term TAIL durations.
  2. With respect to the former duration, however, our conviction is dramatically lower than it was 12-15M ago.
  3. Specifically, we think Japanese economic growth is likely to slow throughout 1H14. To the extent that catalyst results in declining inflation expectations, we’d expect to see a [continued] correction in the USD/JPY cross and concomitant correction in the Japanese equity market.
  4. A immediate-term TRADE breakdown in the aforementioned currency cross (TRADE support = 102.68) will likely result in the exchange rate testing its intermediate-term TREND line of support at 100.06. An immediate-term TRADE breakdown in the Japanese equity market (TRADE support = 15,698) will likely result in the index testing its intermediate-term TREND line of support at 15,045.
  5. The aforementioned TRADE lines a good levels to buy protection to the extent you are looking to hedge for more noteworthy downside in your existing SHORT yen or LONG Japanese equity exposure(s). The aforementioned TREND lines would be a good place(s) to add to existing positions – to the extent you have pared them back or have plans to do so.
  6. Furthermore, there is a rising probability that both the USD/JPY cross and Japanese equities start to actually cheer on bad economic data; that would represent a material inflection from trends observed in years past, but very much akin to what we’ve all observed in the US over the course of 2010-12.

JAPANESE ECONOMIC GROWTH IS LIKELY TO SLOW FROM THESE LEVELS

The consumption tax hike (scheduled for APR 1st) has likely been the most over-analyzed fiscal policy catalyst in the world over the past 6-12M, so we’re not going to waste your time adding to the slew of analysis. Japanese growth is a near-lock to slow in second quarter.

Where we are divergent from consensus is that we think Japanese economic growth slows in 1Q14E as well (i.e. sooner than the market might expect; Bloomberg consensus forecasts currently call for an acceleration to +3.1% YoY real GDP growth in 1Q14).

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - JAPAN

Considering that Japanese economic growth data has been white-hot in recent months/quarters, it’s not exactly going out on a limb to call for it to cool off, at the margins. Tough comps and #InflationAccelerating are threatening to suppress Japan’s consumer-aided recovery from currently elevated growth rates.

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - GDP Comps

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - CPI

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - PPI

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Imports

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Wages

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Consumer Confidence

 

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Retail Sales

Moreover, despite marked improvement in domestic industrial production, manufacturing, capital goods orders, business sentiment, exports, etc., we believe that Japanese corporations have yet to fully buy into the sustainability of Abenomics – as evidenced by their forecasts for the USD/JPY cross and CapEx guidance that remains well off the peaks of previous economic cycles.

As such, the growth rates/index levels of the aforementioned indicators is at risk of slowing from currently-elevated levels until Japanese corporations get substantially more color on the much-anticipated “Third Arrow” of Abenomics (allegedly to be detailed in JUN).

 

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Industrial Production

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Manufacturing PMI

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Capital Goods Orders

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Economy Watcher s Survey

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Exports

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - CapEx Guidance

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Tankan JPY Forecast

DOES SLOWING GROWTH = DECLINING INFLATION EXPECTATIONS OR HAS “KURODA’S CASINO” BROKEN THAT RELATIONSHIP?

To the extent a noteworthy slowing of Japanese economic growth results in declining inflation expectations, we’d expect to see a [continued] correction in the USD/JPY cross and concomitant correction in the Japanese equity market. It’s worth noting that the USD/JPY cross has a +0.85 correlation to Japan’s 5Y breakeven rate over the trailing 3Y.

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - Breakevens

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - JPY vs. Breakevens

Source: Bloomberg L.P.

That said, however, it’s hard to have a high-conviction view on that relationship at the current juncture. The next 6-9M is likely to present Japanese policymakers with their first real test on the economic growth front since Kuroda materially altered the way the BoJ conducts its monetary policy operations.

If Shirakawa were still in charge, we’d actually think about shorting the USD/JPY cross and shorting the Nikkei on a TRADE breakdown in the respective markets. Recall that Japanese capital and currency markets were constantly testing Shirakawa’s will to implement the necessary measures to overcome deflation – a task he ultimately failed miserably at.

Haruhiko Kuroda is a different animal altogether, however. It remains to be seen how much faith the market will have in his willingness to add to the BoJ’s “Quantitative and Qualitative Easing” program and how quickly they anticipate him doing so (80% of economists surveyed by Bloomberg expect additional stimulus measures by SEP). Faith, as evidenced by the net length in the futures and options market remains high – for now at least.

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - JPY Net Length

We too think Kuroda & Co. will continue to fight hard to achieve “+5% monetary math” and that expectation underpins our respective long-term TAIL biases on the yen and Japanese equities as outlined at the onset of this note. Moreover, the preponderance of recent commentary suggests they stand ready and willing to react to any confirmation of lost momentum on either the growth or inflation fronts in the interim.

#GROWTHDIVERGENCES: ALL EYES ON JAPAN - 5  Monetary Math

Furthermore, there is a rising probability that both the USD/JPY cross and Japanese equities start to actually cheer on bad economic data; that would represent a material inflection from trends observed in years past, but very much akin to what we’ve all observed in the US over the course of 2010-12.

These views lead us to conclude that the current correction in the USD/JPY cross and the Japanese equity market are just that – corrections. As such, while our conviction over the next 3-6M is unlikely to be anywhere near where it has been in months and quarters past, we still think it pays to #BTDB in the dollar-yen and Japanese equities if and when the opportunity presents itself.

Feel free to ping me with follow-up questions if you’d like to dig in further on a specific topic(s).

DD

Darius Dale

Associate: Macro Team