“I was instructed by the prime minister to take various, aggressive responses to ensure stability in financial and currency markets.”
-Taro Aso, Finance Minister of Japan
While unilateral intervention in foreign exchange markets by Japan’s Ministry of Finance appears unlikely in the context of staunch opposition from key G7/G20 allies – the United States in particular – we can only hope that any such measures have a better, more lasting impact than Abenomics, which itself has seen its various “arrows” come under tremendous fire of late.
- A Nikkei poll published 6/6 showed that 81% of respondents said the recent consumption tax hike delay will not affect their spending, with 57.6% citing the inevitability of a tax increase at some point in the future and another 20.7% citing an increase in economic uncertainty. That’s not good in the context of real consumer spending tracking at -0.4% YoY and slowing on a trending basis as of the latest reported data (April).
- A Eurekahedge poll published 6/9 showed that only 5% of respondents expect the Nikkei 225 Index to end the year at/near 20,000, down from 85% in last year’s survey. Only 16% of respondents deemed Abenomics as a success – a figure that is down from 72% last year. Despite their disproval of the program, a whopping 90% of respondents expect the BoJ to double-down on what allegedly hasn’t worked – i.e. incremental QQE and NIRP – by year-end.
- A Yomiuri poll published 6/20 showed Prime Minister Shinzo Abe’s approval rating slipping to 49% from 53% previously amid rising discontent with economic policy.
- That same day, a Mainichi poll showed Abe’s approval rating declining to 42% in June from 49% in May. 61% of respondents supported changes to the Abenomics agenda.
- A Yomiuri poll published 6/21 showed that 89 of 117 Japanese firms characterized the domestic economy as “stalling”, with the majority of firms citing sluggish consumer demand.
- An Asahi poll published that same day showed that majority of Japanese firms (51% of respondents) believed that Abe would fail on his goal to expand Nominal GDP to ¥600T by the end of FY20 – a goal that requires a CAGR of +4.6% from FY15, which is a whopping 3.4x the CAGR in the five years ending in FY15.
- A Kyodo poll of Japanese households published one day later showed 62.2% of respondents expressed doubts about the effectiveness of Abenomics.
Back to the Global Macro Grind…
In order to understand the drivers of the aforementioned shifts in popular sentiment, it’s worth reviewing the myriad of economic and financial market factors that have each contributed to the marginal demise of Abenomics.
Starting with markets:
- The easiest place to start seeking evidence of failure is within the Japanese equity market. The benchmark Nikkei 225 Index is down -26.6% since peaking in late-June of 2015. Perhaps even more damning, the TOPIX Banks Index is down -27.5% since the BoJ introduced its NIRP back on January 29th of this year.
- The confluence of NIRP, QQE worth ¥80T annually and forward guidance (Japan’s 2Y OIS Rate has collapsed -35bps YTD to -0.30%) have been unable to stem the rise in the Japanese yen, which is up +17.5% YTD vs. the U.S. dollar and +22.8% since the USD/JPY cross hit its Abenomics era peak of 125.63 on June 5th of last year.
- It’s worth noting that both the Nikkei 255 Index and the USD/JPY cross are back trading at levels last seen just prior to the BoJ’s surprise expansion of QQE in late-October of 2014.
- This dramatic appreciation has led to a collapse in long-term inflation expectations in Japan, with 5Y5Y Forward Breakeven Rates -119bps narrower YoY to 0.2%. Yes, that’s -180bps shy of the BoJ’s +2% “price stability” mandate – the same mandate that remains in a perpetual state of “we’ll accomplish our goal in two years’ time”.
Turning to the Japanese economy:
- As the Chart of the Day below details, EVERY key category of Japanese high-frequency growth and inflation data is slowing on a trending basis, with every growth metric experiencing some form of contraction and headline CPI and PPI in deflation territory as well.
- In the 10 quarters since Abenomics began in late-2012/early-2013, the Japanese economy has experienced a sequential contraction in Real GDP 50% of the time!
- One of the lone bright spots of the Japanese economy during Abenomics has been CapEx growth, which bottomed at -7.2% YoY in 4Q12 and subsequently accelerated to its post-crisis peak growth rate of +11.5% in 3Q15. That has since slowed to +4.3% YoY as of 1Q16. The confluence of cycling peak base effects, the aforementioned melt-up in the JPY (the two series have been co-integrated for the past 10-12 years) and serious doubts about the efficacy of Abenomics among Japanese corporations portends a deep recession in CapEx in the near future.
Alas, it would seem the aforementioned repudiation of Abenomics, at the margins, is well deserved. More importantly, however, this shift in sentiment comes ahead of very critical upper house elections, which are scheduled to take place on July 10th.
Abe’s Liberal Democratic Party (LDP) is hoping to win 57 of the 121 seats in play (1/2 of the total are up for election every three years); pairing that with the 65 seats it already has would give the party a standalone majority in the upper house for the first time since 1989. In order to win the two-thirds majority Abe is seeking in order to ratify Japan’s postwar constitution, the LDP/NKP coalition needs to win a combined 86 seats – which is nothing shy of a tall order.
Some in the LDP consider that an achievable goal, but we’re not so sure. The same 6/20 Yomiuri poll referenced above showed that 35% of respondents said they would vote for the LDP in the proportional representation ballot, down from 42% in the previous poll. Given that the other parties did not notch a noticeable increase in support, we are keen to note that the growing displeasure with Abenomics is occurring in the absence of viable alternatives.
While perhaps unlikely, the magic number on the downside for the ruling coalition is a combined 46 seats; anything less would represent a loss of their mandate in Japan’s House of Councillors in just three short years.
Regardless of outcome, the results of Japan’s upper house elections will have lasting implications for global financial markets – mostly via USD appreciation or depreciation pressure.
Unfortunately, I’m not willing to speculate on the outcome of said elections. Be it Brexit or Donald Trump’s presumed ascendency to the GOP nomination, I think investors the world over have probably learned their collective lesson with regards to betting on political outcomes.
If Abe wins a strengthened mandate for his Abenomics agenda, expect a confluence of aggressive fiscal and monetary stimulus (e.g. ¥10T supplementary budget, helicopter money, etc.) that is reminiscent of his initial splash. If, however, the LDP and NKP coalition falter in their goal to win a majority of seats up for election, expect a confluence of aggressive fiscal and monetary stimulus that reeks of desperation.
Specifically, next month’s upper house elections are unlikely to have a material influence on the likely path of policy given the state of the Japan’s economy and its financial markets, but the market may interpret said policies as either a renewed and sustainable push towards [very investable] reflation or a continued breakdown of the central planning #BeliefSystem amid woeful demographic trends.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.44-1.62% (bearish)
SPX 1 (bearish)
Nikkei 149 (bearish)
YEN 101.15-105.19 (bullish)
EUR/USD 1.09-1.12 (bearish)
Oil (WTI) 44.91-48.62 (bullish)
Gold 1 (bullish)
Keep your head on a swivel,