With the Nikkei 225 up +4.5% WoW, the index is now down only -0.6% since our 2/19 note calling for consolidation in the Abenomics Trade (vs. -4.9% 1W ago). Inclusive of a -0.5% WoW decline, the JPY is now up only +0.4% vs. the USD since the aforementioned date (vs. +0.9% 1W ago).
If you’ve been inappropriately levered long of the Abenomics trade since then, ~150bps of wrong-way PnL probably feels more like a ~1,500bps squeeze in the context of the Nikkei 225 being down -9.9% YTD and the JPY being the 2nd strongest G10 currency vs. the USD in the YTD at +3.4%. As an aside, that is just shy of the +3.5% advance for the AUD, in line with the +3.4% advance for the NZD and followed next by the NOK’s +1.6% gain. Did someone say, “#InflationAccelerating will matter in 2014?” I digress…
You know why we’ve been calling for said consolidation (refer to the aforementioned note), but to recap:
- US economic growth is slowing.
- The Fed will react to slowing growth by getting easier, at the margins – effectively perpetuating the growth slowdown via monetary inflation.
- All of this will occur before the BoJ expands its QQE program, effectively making the Fed the more dovish of the two central banks for at least 3-6M.
In the context of a Japanese fiscal policy vacuum (see: “missing Third Arrow”), we appropriately thought this setup called for a consolidation of the Abenomics Trade. We’ve certainly seen that in the data:
- The net length of the non-commercial futures and options positions in the JPY has tightened from a 6+ year low on 12/24 of -143.4k to -54.7k as of the latest reading.
- That delta puts the current TTM z-score at +1.4x, versus a reading of -3.1x on 12/24, which was precisely 1W prior to the cycle-peak of 105.31 on the USD/JPY cross.
- Speculators now have a cumulative $6.6B net short position in the JPY – good for the lowest level since early NOV ’12… which is coincidentally when we began marketing the subsequently nicknamed Abenomics Trade as one of our core research ideas.
We’ve been writing about points #1 and #2 daily since JAN, so there’s no need for us to waste any of your time proving that out in this note. In fact, our conviction on the intermediate-term outlook for US economic growth remains unshaken amid what has been a golf clap-worthy weather-related bounce domestically. What we will focus on, however, is the next 3-6M outlook from here with respect to Japan’s GIP fundamentals.
Starting with our proprietary GIP process, we do not currently hold out-of-consensus expectations for Japanese growth and inflation dynamics – i.e. a sharp, inflationary slowdown in 2Q followed by a fleeting, disinflationary recovery in 2H.
GDP comps level off from here while CPI comps ramp in 2H. In the context of now-sideways trending inflation in Japan, that only increases pressure on the BoJ to ease by the end of 3Q – especially if Japanese consumer sentiment continues to careen to the downside (think: emerging pressure upon the Abe administration that may lead to intraparty dissension).
Giving respect where it is due, Japan’s economy has been handling the +300bps consumption tax hike perhaps a little better than expected (but still terribly on an absolute basis). In going through all of Japan’s key high-frequency economic data that has been reported for the 2nd quarter, there are three trends that jump out to us thus far:
- The initial decline was very sharp, but the 2nd derivative ceases to remain negative on a forward looking basis. The juxtaposition between APR and MAY PMI data, as well as current and future expectations for the Economy Watchers Survey and Small Business Sentiment support this conclusion.
- The sharp deceleration in growth was most felt in the consumer facing sectors, while the manufacturing and export sectors showed resiliency. The juxtaposition between APR Retail Sales and Imports data and APR Machine Tool Orders, Exports and Trade Balance data supports this conclusion.
- The tax hike was definitely passed on to producers and likely to consumers as well, given the weakness in Retail Sales. This means the GDP Deflator will play a prominent factor in determining the rate of Japanese Real GDP growth in 2Q. This hasn’t been the case since 4Q08, when the GDP Deflator jumped from -0.8% QoQ to +1.5%; it came in at -0.2% QoQ for 1Q, which is in line with its trailing 3Y average of -0.2%.
We are also no longer out of consensus with regards to our outlook for Japanese fiscal and monetary policy – i.e. we also think the BoJ expands upon its QQE program by the end of 3Q or early into 4Q (statements on JUN 13, JUL 15, AUG 8, SEP 4, OCT 7 and OCT 31) and we think the Third Arrow of Abenomics has increasing potential to surprise consensus expectations to the upside with respect to corporate tax cuts, GPIF reform, corporate governance and/or labor market reforms come next month’s supposed introduction.
Basically anything that will be interpreted as simulative to meaningful domestic CapEx expansion should be taken as a major positive amid continued #PayMeNow corporate governance in Japan; dividend payments by Japanese enterprises grew +20% in FY13 to a record ¥6.9T and 47% of companies plan to resume or hike payments further.
Rather than speculate on either of these fiscal/economic policy catalysts amid their respective deliberative processes, we’ll just continue to read the tea leaves and react accordingly; email us if you’d like us to discuss the latest happenings further.
All told, our fundamental GIP outlook leaves us very much in consensus on a lot of things Japan – which means we should not be trying to call for contrarian outcomes with respect to Japanese capital and currency markets on Japanese fundamentals alone.
We still have a ton of conviction in our contrarian bear case on US GIP fundamentals, so assuming we’re in the area code of right on both catalysts, it’s hard to know which will be more favored by investors going forward (we’d argue that it’s been all US #GrowthSlowing thus far).
As such, it no longer makes sense for investors to continue aggressively playing for counter-trend deltas in Japanese stocks and the JPY. To the extent you’ve done so – either by pairing back equity long holdings or outright selling them short – we think it makes sense to begin the unwind process of that trade.
This is especially true in the context of TACRM signals that, for the first time since 2013, are showing DM Equities gain relative momentum at the primary asset class level in lieu of FX and Commodities. Assuming this is the start of a trend, that Global Macro beta would be positive for Japanese equities and negative for the JPY.
In short, the risk of consensus finally being right on Japan – based solely on Japanese fundamentals alone – is a lot higher now than it has been in the YTD.
Best of luck out there,
Associate: Macro Team