The Japanese anti-deflationary plan is well into its second year and under close scrutiny to capture any hints about the effects of Abenomics, the massive economic measures enacted in 2013 by Prime Minister Shinzo Abe, and named after him.
Is Abenomics working?
Recent figures on Japan’s output show the largest drop since the 2011 earthquake and a significant reduction in consumers spending are hinting the Ministry’s inflationary strategy is not working as anticipated.
Continued weakness in the Japanese Yen may help large exporters, lately reporting increase in profits. However, inventories are on the rise because exports to emerging markets, China and U.S. have been unable to compensate the drop in domestic demand.
Domestic Japanese consumption dropped from May after the hike in the sales tax, now at 8%. Consumers have reacted “by cutting spending, with retail sales falling more than expected in June, and household spending dropping for a third month”, explains Bloomberg’s analyst Keiko Ujikane, commenting recent data.
Some analysts are particularly cynical of current plans to further increase the Japanese consumption tax to 10% by the end of 2014. A decision Finance Minister Taro Aso is still evaluating, given also an anticipated GDP rebound of 2.4% in Q3. However should not forget that the 1997 decision to hike the tax from 3% to 5% – by then-prime minister Ryutaro Hashimoto – triggered a 20-month recession and a recovering trend in retail sales at that time went into reverse for about a decade.
What Japan needs
Abenomics is not yet working as hoped and the so-called “third arrow”, the competitiveness part of the Prime Minister’s agenda, is still lacking. Fiscal and monetary arrows can only do so much without structural changes.
In June 2014, a bundle of new and apparently sound structural changes has been unveiled by Shinzo Abe, including strengthening corporate governance and increasing women’s participation in the workforce. But Bloomberg analysts noted that “they fall short of the frontal attack on labor, immigration and tax laws that Japan still needs”.
Concerns shared by David Lipton, first deputy managing director of the IMF, who mentioned that IMF “main concern is whether Japan could forcefully implement structural reforms to shore up its sliding potential growth and export competitiveness”, Reuters reports.
It appears that Abe would do more to strengthen Japan if he refocused his energies where they are most needed, i.e. at home, where he faces opposition from both major business lobbies and within his own party. The Prime Minister, on the other hand, has been busy on managing rivalry with China, and recently traveling across Australasia in a five-nation visit of frustrated attempts to boost exports.
The Prime Minister is also spending some of his dwindling political capital on a new security policy that, even if makes sense, and it is obviously supported by the United States, it’s unpopular. In fact, Abe’s government “recently revised Japan’s position on defending friends and allies that come under attack, softening the country’s post-war commitment to pacifism”, Bloomberg reports.
Fiscal and Monetary policy
With the second highest debt/GDP ratio in the world after U.S., real incomes have been under pressure since the sales tax increase in April, a rise required to get Japan’s public debt back under control. Meanwhile, “companies are sitting on $2.3 trillion in cash, rather than investing it in new machinery or raising wages”, according to Bloomberg.
Monetary stimulus has driven down the Yen, but that only partially boosted exports while making imports more expensive. Domestic prices are rising, too — as intended — but, with consumers retracting, the Bank of Japan’s ability to raise inflation to its two percent target is still in doubt.
The degree BOJ has begun shifting its focus from supporting growth to phasing out the massive stimulus, to end two decades of deflation and fitful growth, is yet unclear. Certainly the BOJ, at this point in time, can still engage a longer-than-expected easing “JQE2” cycle.IMF’s David Lipton thinks the Yen is “slightly undervalued against Japan’s medium-to long-term economic fundamentals” and sees this trend correcting itself over time.
Lipton also said the “BOJ’s current policy is appropriate and he saw no need for the bank to prepare an exit or ease policy more forcefully, although it should remain vigilant against risks such as return of deflation.” (Reuters)
How global macro factors affect Japan and the Yen
Although Japan is mainly driven by domestic economy, it is still important to understand how the major macro factors are likely to affect its prospects and currency.
At the moment the main global themes, along with Abenomics,are the US Fed tapering and Bank of England anticipating a potential hike, the ECB swamped in a deflation battle and China slowdown.
The Obama administration had to face the “fiscal cliff” conflict and forcefully cut expenditures. The U.S. government has recovered to a certain level,”but it cannot avoid fiscal reconstruction, especially cutting the national defense budget” according to Chugoku-keizaiSuitai de Donaru Nihon (The Chinese Economic Slowdown — How Does It Affect Japan?).
The FED is showing signs that a rate hike may happen early in 2015 and tapering continues. The effects of tapering are negative for emerging markets as it could result in large scale capital outflows, with potential tightening liquidity in China and other BRICs. However, there are discording views.
Frederic Neumann, head of Asian Economics Research at HSBC,maintains that tapering of QE in the U.S. isn’t going to have a large impact on China, because the BOJ will continue easing. BOJ announced plans to nearly double its monetary base to $2.9 trillion by the end of 2014, to pump money into a flagging Japanese economy, and it is potentially just at the start of ramping up its quantitative easing and expanding its balance sheet. “The BOJ is easing a lot and some liquidity created should offset the withdrawal of liquidity by the FED”, Neumann said.
Moving to the effects of the European crisis on Japan, Atsushi Nakajima, chairman of Research Institute of Economy, Trade and Industry explains that “Japan’s exports to the EU are just 10% of its total exports”, so decreases in exports have a minimal effect on the Japanese economy.
Exports accounted in 2013 for a mere 15.1% of total Japanese economic output, or $715.2 billion, translating to roughly $5,627 for every person in the country. By exports as a share of GDP, Japan is in 137th position, in a chart ranking 147 countries. “Another chart – for inward foreign direct investment as a proportion of GDP over the past three decades – showed Japan at number 184 out of 185 countries”.
And finally, the China slowdown, an inevitable ongoing event that not necessary means doom and gloom for the global economy, including Japan. It really depends on how China will rebalance its internal economy and hopes are the transition from a credit and export driven economy to one driven by consumer growth will be smooth. Professor Micheal Pettis of University of Peking,compares the challenges of China’s economy with those of Japan during the 1990s, suggesting that orderly rebalancing could prevent social unrest. “As Japan was forced to rebalance its economy after 1990, one of the implications was that household income and consumption grew as a share of overall GDP, just as it must in China.”
Japan has reduced its total exports to China from 23% in 2011 to around 20% in 2013, same levels as Brazil and Malaysia, and would certainly suffer less than Australia and South Korea from a continued slowdown in China.
Technical view of USD / Yen and what lies ahead for the Japanese currency
Considering the continued intervention of BOJ and the risk of extension of “JQE2”, the uncertainty on the execution and effectiveness of Abe’s “third arrow”, the Damocles sword of an additional two percent sales tax increase by end of 2014; and, on the side, the Dollar strength, a recovering economy in US and the prospects for a rate hike in 2015; plus a downward pressure on exports due the European crisis and the China slowdown, it seems there is enough to believe that the Japanese Yen will be subjected to continued downward pressure.
In the figure below is a weekly chart of the USD / JPY forex pair showing participation of professional traders and classes of algorithmic getting involved on the long side around the 94 area. This offers confirmation to provided fundamental outlook.
Figure – Weekly chart of USD / JPY showing upward pressure
Algos and professional traders are looking at targets in the 108.30 area, and as high as 115.80, before profit taking may kick in and bring the pair back to the 108 area. On the daily timeframe the support area starting at 101.50 has been able to hold price higher since the beginning of 2014. Higher prices into the indicated targets should be anticipated in the coming 6 months.
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