One of the requests subscribers have asked for most over the last few years has been to have an easy way to find what positions I have open at any given time. Therefore, I repost this section on a daily basis and the title will always include the date of my most recent trade.

Driven by the tightest labor market in decades, wages in Japan have grown steadily since mid-2017, and even real wages are starting to pick up. That’s welcome news for the Bank Japan, which recently adjusted monetary policy in an effort to make its easing program more sustainable. If households become convinced that pay hikes will keep coming, they’ll be more willing to increase spending, which will drive further price increases and economic growth. The problem is that employers favor pouring pay hikes into bonuses, which can be taken away, rather than permanent increases in wages.

Employers are paying higher bonuses but are so far demurring from committing to higher wages. However, continued tightness in the labour market, rising participation rates and the breakout in wage growth suggests the trajectory of higher wage growth is a medium-term consideration.

The latest survey shows manufacturers boosting capital expenditures by 27.2%. This is due in large part to investment and research and development outlays for electric vehicles, on top of redesigns. Extending ranges for electric autos requires development of better batteries and other onboard components. On that front, chemical and electric machinery makers are expected to step up their own investments.

For the nonmanufacturing sector, spending is forecast to rise 18.5%. In addition to urban construction projects, contractors are building massive logistics centers to handle a surge in online orders. Construction starts for hotels remain high ahead of the 2020 Tokyo Olympics.

For the first time in its survey, the DBJ asked companies about the impact of labor shortages. About 60% of nonmanufacturers said a lack of workers is hindering business development. Furthermore, they see the situation growing worse three years down the road. The DBJ expects this to drive more labor-saving investments among retailers and wholesalers.

Japan is booming and labour-saving investments are not going to overcome the lack of available workers. There are now almost as many women in the work force as men. Meanwhile, the reality on the ground is that the country has opened the doors to foreign workers and that means more demand for just about everything since new arrivals have to start from scratch.

A dramatic day for Japan’s debt market saw yields surge on media reports of possible changes to the nation’s ultra-loose monetary policy, spurring the central bank to offer to buy an unlimited amount of bonds.

The yield on 10-year government securities soared as much as six basis points to 0.09 percent, its biggest increase in almost two years, pulling the yen higher and weighing on stocks. While the yield came down after the purchase offer by the Bank of Japan, it then bounced back to just one basis point below the day’s high.

Any change to BOJ’s stimulus would be the first since 2016 when it introduced control of the yield curve in a bid to manage the impact of its bond purchases and negative interest rates. Still, profits for banks and bond traders continue to be depressed, with reports from Reuters, Asahi and Bloomberg suggesting that officials are debating ways to further mitigate the side effects.

Niru Devani’s view

In response to a spike in yields, the Bank of Japan said it would purchase an unlimited amount of 10-year Japanese government bonds if the yield hit 0.110 per cent, above the 0% to 10% range it set in 2016 to support economic growth and raise inflation. It is worth pointing out that it is rare for the Bank of Japan to use such a mechanism to stabilise the bond market and seems to be the latest sign that loose monetary policy globally could be coming to an end. 

FullerTreacyMoney has a very varied group of people as subscribers. Some of you like to receive our views in written form, while others prefer the first-person experience of listening to the audio or watching daily videos.

The Big Picture Long-Term video, posted every Friday, is aimed squarely at anyone who does not have the time to read the daily commentary but wishes to gain some perspective on what we think the long-term outlook holds. However, I think it is also important to have a clear written record for where we lie in terms of the long-term themes we have identified, particularly as short-term market machinations influence perceptions.

Among 20-somethings living in Japan's capital, one out of 10 are foreign-born, reflecting the rapidly shifting profile of the country's working population.

Throughout Japan, foreigners in their 20s numbered 748,000 at the beginning of the year, or 5.8% of the total, the government reported Wednesday. The figures exclude foreign nationals that are here for short stays, and typically include those with residency credentials staying for over three months.

In all, the country's population of non-Japanese residents grew 7.5% to a record 2,497,000 people. Many of them live in Tokyo, with the largest portion -- around 42,000 -- housed in the city's Shinjuku ward.

At 3 p.m. on weekdays, Shinjuku's government offices are jam-packed with people filling out moving notices and other forms. Over half of those waiting in line are young people of non-Japanese descent, and a mixture of English, Chinese and other languages fills the air. More than 40% of the foreigners are 20 years old.

While Shinjuku's native-born residents in their 20s shrank 7% over five years, the number of foreigners in the ward soared by 48%. One convenience store near JR Shinjuku Station has hired a 31-year-old Chinese woman. "The store wouldn't run if I'm away from my shift," she said.

One of the most widely repeated objections to Japan’s ability to reform and growth is its reluctance to absorb young immigrants who have been engines for demand elsewhere.

FullerTreacyMoney has a very varied group of people as subscribers. Some of you like to receive our views in written form, while others prefer the first-person experience of listening to the audio or watching daily videos.

The Big Picture Long-Term video, posted every Friday, is aimed squarely at anyone who does not have the time to read the daily commentary but wishes to gain some perspective on what we think the long-term outlook holds. However, I think it is also important to have a clear written record for where we lie in terms of the long-term themes we have identified, particularly as short-term market machinations influence perceptions.

I realise this summary at 4600 words is getting rather lengthy which is why I decided to right another book to more fully explore the issues represented by the rise of populism and what that means for markets and the global economic order. I’ve agreed an August/September deadline so hopefully it will be available this year.

The figures come at a critical time for Japan’s mission to generate stable inflation. Price growth has softened in recent months and household consumption continues to show signs of weakness. Separate data released Friday showed household spending slid 3.9 percent in May from a year earlier.

Atsushi Takeda, chief economist at Itochu Corp., says strong gains in wages will be needed for many more months before consumption is likely to show a response.

"There’s no question that wages are improving," he said, commenting on the latest figures and citing the results of annual wage negotiations earlier this year. "But people need a substantial period of wage gains to be convinced that wages will keep rising."

The gain in overall wages was partly attributable to a 15 percent jump in bonus pay that reflects continued strength in Japanese corporate earnings.

Japan has a tight labour market, where more women are being encouraged into the workforce and the number of immigrants is rising as jobs go unfilled. Bonuses are not enough to stoke consumerism because they are by nature a one-off event so persistent wage gains will probably be required to stoke consumer demand.

FullerTreacyMoney has a very varied group of people as subscribers. Some of you like to receive our views in written form, while others prefer the first-person experience of listening to the audio or watching daily videos.

The Big Picture Long-Term video, posted every Friday, is aimed squarely at anyone who does not have the time to read the daily commentary but wishes to gain some perspective on what we think the long-term outlook holds. However, I think it is also important to have a clear written record for where we lie in terms of the long-term themes we have identified, particularly as short-term market machinations influence perceptions.

Here is a summary of my view at present:

A link to the full report and a section from it are posted in the Subscriber's Area.

Long-term trends change the fundamentals of a market and Japan is one of the most relevant examples of that in the world today. The deflationary environment has prevailed for so long that that I am reminded of the quip from the commodity markets “those who know it best, love it least because they have been disappointed the most”.

I believe this does rather endorse your view. Also, my father in law a farmer in Shikoku has told me about many Chinese farmers on their Island!

Different subject, but I heard recently pearl exports this year are up in the region of 100%, your wife has obviously started a major new trend!

Thank you for this informative email and interesting article. My wife’s pearl business, my children’s love of anime and mange and my optimism about the recovering economy created a trifecta of reasons for our original trip and return visit in April.

The biggest takeaway for me is the number of foreign workers we have encountered. In one of the world’s few remaining mono cultural societies that was a true surprise. Here is a section from the Nikkei Asian review article: 

The demand for construction workers is intensifying before the 2020 Olympics, and Hoang is one of the 274,000 foreign workers in Japan on a government-backed trainee program that has become a back door for foreign unskilled workers who would otherwise not be allowed in. Started in 1993, the program has boomed in recent years -- and is one reason that the number of foreign workers in Japan has nearly quadrupled over the last decade.

Led by an influx of workers from China, Vietnam and the Philippines, Japan is in the midst of a quiet revolution when it comes to immigrant workers. Though the total number of foreign workers in Japan is small compared to the more than 3 million in the U.K. and Germany, it is catching up rapidly -- a remarkable shift for a nation famous for resistance to immigration.

Without fanfare, Prime Minister Shinzo Abe has steadily loosened Japan's once tightly controlled visa policy, resulting in an almost doubling of the number of foreign workers in Japan to 1.28 million over the last five years. In its latest move, Abe's government is expected to create a new class of five-year work permits for unskilled workers in hopes of attracting more than 500,000 new overseas workers by 2025. The new guidelines, to be finalized in June, will ease language requirements for foreign workers in construction, agriculture, elderly care and other sectors that are suffering the most serious labor shortages. It will also be possible for trainees to extend their stay for up to 10 years.

FullerTreacyMoney has a very varied group of people as subscribers. Some of you like to receive our views in written form, while others prefer the first-person experience of listening to the audio or watching daily videos.

The Big Picture Long-Term video, posted every Friday, is aimed squarely at anyone who does not have the time to read the daily commentary but wishes to gain some perspective on what we think the long-term outlook holds. However, I think it is also important to have a clear written record for where we lie in terms of the long-term themes we have identified, particularly as short-term market machinations influence perceptions.

Here is a summary of my view at present:

One board member said the bank needs to make it clear that there is no change in its commitment to fulfill the objective as soon as possible, according to the summary, which don’t identify who said what. Kuroda said the BOJ will continue easing “very persistently” at a press conference following the policy decision.

BOJ’s updated price forecast for four years through fiscal 2020 was also released on April 27, showing no board members see inflation rising above 2 percent in a stable manner.

“In order to continue with powerful monetary easing, the bank needs to constantly consider enhancing its sustainability while aiming to gain consensus among the public on the necessity of the price stability target,” one board member said.

One member said an early rate hike would result in multiple adverse effects, including falling bond and stock prices, while a stronger yen would cut into corporate profitability.

Real Estate prices are the primary drag on inflation from the latest BoJ report. That is perhaps not so surprising with a shrinking population. However, the other point that needs to be borne in mind is that job openings are rising, labour force participation is high and wages just broke out. Against this background the BoJ is not going to be removing stimulus any time soon and may even increase it.

The central bank’s quest to restore sustainable inflation of just under 2 percent has been complicated by data suggesting that the euro area’s strongest growth in a decade may be faltering. As well as waning industrial output and deteriorating business confidence, the threat of a global trade war is hanging over Europe’s export-oriented economy.

“Incoming information since our meeting in early March points towards some moderation, while remaining consistent with a solid and broad-based expansion of the euro-area economy,” Draghi said. “The underlying strength of the euro area economy continues to support our confidence that inflation will converge towards our inflation aim of below, but close to, 2 percent over the medium term.”

Mario Draghi’s statement “An ample degree of stimulus remains necessary.” Is what the market was expecting. The ECB and Bank of Japan remain the primary providers of liquidity to the global economy so when they eventually begin a process of quantitative tightening is likely to be an important catalyst for liquidity fueled uptrends.

Thank you for your kind concern and this educative email. I checked the data on Bloomberg and there is very little variation with what you quoted.

The Dollar has been on a downward trajectory for most of the last two years but is now in receipt of some respite not least because the interest rate differential has moved in its favour and yields are testing the psychological 3% level. Against the Yen it has now unwound its oversold condition relative to the trend mean so this is a level where investors will be asking whether the rebound has the legs to keep going.

I have noticed re the Japanese charts that the Topix second section now seems to be leading on the downside having broken through the 7000 level. Should this be a concern?

The Topix 2nd Section was a topic of conversation at The Chart Seminar over the last few days.

It has been a reliable lead indicator for the market for as long as I can remember and it will need to bounce soon to confirm support in the region of the trend mean.

My daughters love visiting Japan. They adore anime and manga, and no they are nor the same thing, I’ve been reminded more than once. They love the cutsie culture coupled with the storytelling and fact that a lot of the topics covered are more mature in nature than they would be conventionally exposed to at home.

In my 10-year old’s class there are two things that every child, regardless of background, intelligence or wit loves; slime and squishes. Slime has turned every girl in the nation into a chemist and our house is full of the products my daughter has concocted from mixing varying quantities of Elmer’s glue and borax and lotion. I’m really hoping that one is a phase, the stuff is gross to my eyes. The other thing they love are Squishies. These are what many of us might think of as stress balls. The most popular are Japanese because they are of higher quality and return to their shape slowly. If you can bare it simply plug Squishies into YouTube.

Squishies, anime and manga, robotics and a range of other genres highlight the fact that Japan is still capable of capturing the imagination of popular culture. Against that insight more than a few people told me that the country is managed for old people. It is a common sight to see nonagenarians being wheeled around by their sexagenarian offspring. Massage and pain treatment for backs, necks and knees are some of the most common store fronts. Something politicians and the general public are only beginning to get grips with in Europe and North America is that older people are reliable voters and are jealous of their pensions and senior perks.

"If it hadn’t been for the BOJ’s ETF buying, the Nikkei 225 would have breached 20,000," said Ayako Sera, a market strategist at Sumitomo Mitsui Trust Bank Ltd in Tokyo. "For investors, March was a month to reduce exposure to Japanese equities."

The BOJ bought 1.9 trillion in ETFs in the first quarter, which is 32 percent of its annual purchase goal. To be sure, Kuroda has said that the target isn’t set in stone at exactly 6 trillion per year, and annual purchases don’t necessarily have to be measured from January to December. On Tuesday, Kuroda said the central bank is discussing how to eventually exit from its massive monetary stimulus but that it’s still too early to reveal details.

Not that long ago, many investors expected the BOJ to join the global trend toward stimulus tapering by reducing ETF buying this year. That came after the Topix and the Nikkei 225 soared to their highest levels in a quarter century. But then the market slumped, and the situation changed.

Foreigners have muddied the picture, dumping Japanese equities as the yen gained to a 16-month high against the dollar. They yanked almost 8 trillion yen from cash equities and futures in the first quarter alone, according to data through March 23. Suddenly, not many people are expecting a BOJ taper anytime soon.

Tatsuya Oguchi, chief executive officer and president of Franklin Templeton Investments in Japan, says the BOJ won’t rush to alter its ETF purchases.

"Obviously, the BOJ has to stop buying at some point," Oguchi said. But "I think we have to wait until the Tokyo Olympics” in 2020, he said. “The BOJ won’t change their policy at least for another two three years."

Kiyoshi Ishigane, chief strategist at Mitsubishi UFJ Kokusai Asset Management Co. in Tokyo, agreed. “Of course, they won’t cut back," Ishigane said. Like the others, he doesn’t expect the bank to increase the target, either. "The BOJ would buy more if they could stop the market from falling, but it knows that it can’t."

Bank of Japan buying of stocks represents a powerful tailwind for the market. Both the Bank of Japan and the Swiss National Bank have been actively buying shares, in addition to bonds, in an effort to promote inflation. This policy has the added benefit of the central bank gaining interests in tangible assets with no fixed maturity dates. Dividend growth potential then offers at least a partial inflation hedge to central banks they might not otherwise have had.

Just as hedge funds pile into wagers betting on dollar-yen weakness, signs are emerging that the pair is poised for a resurgence in Japan’s new fiscal year.

The greenback’s failure to break below 104.50, seen by major Japanese banks as a key barrier amid a congestion of buy orders, is pointing to a potential bottom for the widely traded cross. That’s bad news for speculators that suddenly turned bearish for the first time in almost a year this month as an escalation in global trade tension and a domestic political scandal spurred demand for Japan’s haven currency.

The culmination of the country’s fiscal year this week -- which has historically capped dollar strength amid repatriation flows -- month-end fund rebalancing and easing trade tensions are creating the conditions for a dollar bounce against the yen, according to traders and strategists. The rebound looks to have already begun, with the pair climbing as high as 106.41 Wednesday as Japanese importers were seen selling the domestic currency.

“With Japan’s new fiscal year starting shortly, I expect a certain degree of yen selling flows to emerge,” said Tohru Sasaki, head of Japan markets research of JPMorgan Chase & Co. Flows related to the start of the fiscal year could push dollar- yen upward toward the 111 to 112 area, he added.

The Dollar has been among the weakest currencies in the world so far this year, amid widespread angst about the implications of fiscally profligate policy on the value of the currency. However, the USA is also raising interest rates and that interest rate differential is beginning to be meaningful, particularly as LIBOR rates for short-term paper advance.

FullerTreacyMoney has a very varied group of people as subscribers. Some of you like to receive our views in written form, while others prefer the first-person experience of listening to the audio or watching daily videos.

The Big Picture Long-Term video, posted every Friday, is aimed squarely at anyone who does not have the time to read the daily commentary but wishes to gain some perspective on what we think the long-term outlook holds. However, I think it is also important to have a clear written record for where we lie in terms of the long-term themes we have identified, particularly as short-term market machinations influence perceptions.

Here is a brief summary of my view at present.

Governor Haruhiko Kuroda made it clear last week the current stimulus program will remain in place for a while. There’s concern that any move past 100 could prompt a policy response if it’s deemed to hurt attempts to reflate the economy. However, his remarks on March 2 that the bank will start thinking about a stimulus exit in fiscal 2019 have at least increased market speculation over the timing of a possible normalization.

Kuroda’s mention of an exit was meant to prime markets for an eventual withdrawal, says Daisuke Uno, chief strategist at Sumitomo Mitsui Banking Corp. in Tokyo. “Given the reduction in bond purchases, the BOJ is already laying ground for an exit. It just isn’t saying so.”

 

The Bank of Japan will likely be the last of the major central banks to exit its quantitative easing program. With the ECB due to complete tapering by September that suggests Japan’s program will end sometime in 2019. That is of course under the assumption exogenous factors do not required it to be extended even further.

"The workforce is becoming more and more global, so to attract and retain the best people, you need to be prepared to pay competitive salaries," said Marc Burrage, managing director of Hays Japan. Seniority-based pay systems are among the reasons for Japan’s low salaries, he said. "It’s a concerning situation and if it’s not addressed soon, it will start to bite in terms of productivity."

Mrs. Treacy is planning a trip to Japan in April to source Akoya pearls so the girls and I will be tagging along to Kobe and Osaka. I asked a long-time subscriber in Japan what his perception of rising inflationary pressures is. Here is his response: 

The yen briefly weakened Friday when local media reported Prime Minister Shinzo Abe is set to nominate Kuroda for a second five-year term, strengthening speculation that has been in the market for weeks. Kuroda’s record easing helped push the yen to almost 126 per dollar in mid-2015, the weakest in more than a decade. The currency was at 108.43 on Tuesday.

The Federal Reserve started to trim its balance sheet last year, while the European Central Bank is also looking to unwind stimulus. Few economists predict the BOJ will deepen its already unprecedented easing after Kuroda failed to achieve a 2 percent inflation target in his first term. Foreign investors think if the BOJ can’t expand stimulus, its next step will be a move toward an exit. Domestic investors only see policy being tweaked.

The Bank of Japan is at a crucial juncture because right now Japan is the only country running both easy monetary and fiscal stimulus. The Eurozone is close because it is tapering its quantitative easing while the fiscal austerity strait jacket has been loosened. Concurrently, the USA is swapping monetary largesse for fiscal largesse and there is already talk of an additional infrastructure bill which is only likely to add greater fiscal stress to the budget. 

S&P500 Consumer Staples has lost momentum over the last couple of years with larger pull backs that dip into the underlying range and somewhat less impressive rallies subsequently. Last week’s downside weekly key reversal with follow through this week represents another in a series of failed upside breaks. It is back testing the region of the 200-day MA and will need to continue to hold the 550 area if top formation completion is to be avoided. 

Re Japan, you discussed previously how one might get exposure to the Japanese financial sector. One obvious candidate would be the NYSE quoted ADRs in Nomura. In the past the Topix Securities Index has moved in line with the Japanese Banks Index. My question is do you think that times have changed so much that a stock like Nomura is no longer a good geared play on the Nikkei?

Thank you for this question which may be of interest to other subscribers. Japanese banks have been laboring under the low interest rate regime for what must feel like forever but the introduction of simultaneous monetary and fiscal stimulus during a period of synchronized global economic expansion has the potential to kick start inflation not least because of labour shortages. 

We can see immediately that more production means a larger GDP and that more production requires more workers, ceteris paribus (that is setting aside other considerations that can affect employment such as automation, productivity etc.). Most of the workers in any country would be its nationals. So usually a country’s desire to raise its GDP has a lot to do with the wish to create more employment for its people. But I would argue that Japan’s situation is quite different.

Japan’s labour force is shrinking. It has been shrinking at the rate of 0.4% in the past decade and by all accounts the rate of decline will rise in the coming years. So unsurprisingly Japan’s unemployment rate is very low. Unemployment rate has fallen below 3% recently, which makes Japan’s unemployment rate among the lowest in the world. True, Japan still has a large source of untapped labour; women’s participation in the job market is very low. And that is a pressing issue but it is not really relevant to this discussion. Perhaps I might write about women’s participation in the job market one day but for now, regarding whether moving some manufacturing to the US isn’t such a bad idea, suffice to say that Japanese manufacturers are facing difficulties filling job vacancies in Japan because of Japan’s shrinking labour force and ultra low unemployment rate.

Japan’s challenge today is not about reducing unemployment. Japan’s challenges today are about coping with the social costs of and economic headwind from an aging population and a shrinking labour force. 

So we see that the raison d’être for GDP is no longer that compelling for Japan. Japan should aim to maximise its gross national income (GNI) instead.

Japan is a case study for how other countries with substantial national assets, globally oriented manufacturing centres, aging populations and threatening deflation can cope and prosper.
 

Just read your piece on Japanese financials

What is the issue with Tokyo listed stocks? There are no restrictions for non-Japanese investors to buy local stocks, at least from the perspective of a European investor.

Why do you mention only ADR and GDR? (btw. German listed GDR have often very poor liquidity)

Btw: Wisdom Tree used to have a hedged ETF on Financials: WisdomTree Japan Hedged Financials Fund (DXJF) but I don’t know if it is still actively traded

Finally: Do Japanese REITs also belong to this category of possible beneficiaries from rising J-yields like banks in your opinion?  The iShares Japan REIT ETF trades under ticker 1476 JP

Thank you for this email which others may find of interest. I’ve been writing about Japanese banks since the summer but certainly with more frequency over the last month and I posted a more detailed review of Japanese Banks and REITs on December 8th. 

Governor Haruhiko Kuroda said at a press briefing that the central bank didn’t need to reconsider its current policy framework. 

His comments last month on the "reversal rate” theory stoked speculation about an earlier policy exit. The theory posits that monetary stimulus could end up hurting commercial banks’ profitability, making them less likely to lend. 

Kuroda said Thursday that financial intermediation hasn’t been impaired in Japan and that talk about the theory doesn’t indicate any need for policy change. The yen weakened following the comments and traded at 113.57 per dollar at 5:12 p.m. in Tokyo.

"Just because I brought up this academic analysis, reversal rate, doesn’t mean at all that we need to review or change the yield curve control we’ve adopted since September last year,”

Japan is one of the only major economies running both easy fiscal and monetary policy right now and that is contributing to asset price inflation if not the kind of inflation the central bank measures. In fact, we have learned from QE programs elsewhere that asset price inflation is what to expect from monetary accommodation on the scale employed by central banks at present. 

Japanese shares rose with the Nikkei 225 Stock Average advancing to its highest since 1992 on a weaker yen, as upbeat jobs data from world’s largest economy reignited optimism over global growth.

Japan’s currency slid to a one-month low against the dollar after Labor Department figures Friday showed the U.S. added more jobs than expected in November and the unemployment rate held at an almost 17-year low. Both the Nikkei 225 and the broader Topix index advanced for a third day, with banks and machinery makers providing the biggest boost. Local equities are bouncing back to their highest levels in a quarter century following a pullback in late November on profit-taking.

“The global economic expansion isn’t over yet,” said Tatsushi Maeno, a senior strategist with Okasan Asset Management in Tokyo . As the yen heads lower “investors will anticipate upward revisions to corporate profits ahead of the earnings season in March.”

Both main stock gauges retreated briefly on Monday as technology companies slid in the wake of the sector’s recent global selloff. A measure of electronics makers finished 0.1 percent higher after slipping by as much as 0.6 percent.
“Performance for semiconductor stocks like Tokyo Electron is sluggish with investors torn over whether it’s alright to take an optimal view on the sector again,” said Hideyuki Suzuki, a general manager at SBI Securities Co.

 

The Nikkei-225 has been ranging above 22,000 since early November and closed at an incremental new high today. Upside follow through tomorrow and a sustained move above 23,000 would reassert medium-term demand dominance. The broad Topix Index has now also moved to a new 25-year closing high and importantly these indices are doing so on a much lower valuation than Wall Street. 

A section from the report is posted in the Subscriber's Area. 

A link to the full report is posted in the Subscriber's Area.

Japan has been fighting deflation for so long very few believe it will ever overcome the challenges it faces. However, Japan is now one of the only countries running both easy monetary and fiscal stimulus. The only thing we can definitely credit quantitative easing with in the USA is asset price inflation and that should be equally true of Japan. 

“The MSCI Japan Index now trades on 15.1x 12-month forward earnings, or an 18 per cent discount to the MSCI USA Index’s 18.4x,” Wood reports. “It is also a major structural positive that earnings growth is increasingly coming from domestic-focused [rather than export-focused] corporates.” That means shares generally are less dependent on favourable moves in the yen-dollar exchange rate. 

The worsening labour shortage should lead sooner or later to accelerating wages, boosting consumption. 
“This dynamic has already been evident for some time in the case of temporary workers. But to the longstanding frustration of both the Abe government and the Bank of Japan, wage rises for permanent employees have remained minimal, primarily because the trade unions have been more concerned about keeping their employees “permanent”, since such permanent full-time staff, on average, still earn 1.8 [times] the hourly wage for part-time workers.”  

Companies have been keeping a tight grip on pay increases – one reason why listed firms are enjoying record profits and sitting on record amounts of cash, even allowing for the effect of increasing share buybacks. 

There is a long-term trend for Japanese companies to be more generous with their dividend payouts to shareholders. Back in 2004 the payout ratio (dividends as a proportion of earnings) for the Topix index was only 17 per cent. Now it’s up to 30 per cent.

 

A link to the full report is posted in the Subscriber's Area.

Japan’s economy is recovering momentum and the uptick in performance by domestic companies has been readily observable in the performance of the Topix 2nd Section Index. This revolution has been enabled both by the Bank of Japan’s quantitative easing program and that government’s willingness to run simultaneous fiscal stimulus.

Volatility roared back into the U.S. equity market as fresh concern about the prospects for tax reform sent the Cboe VIX Index to its biggest surge since August.

“In terms of how we see the world and the impact to our strategy, to the extent this reform causes some uncertainty, that could lead to a pickup in volatility,” said David Jilek, chief investment strategist for Gateway Investment Advisers. “But we don’t have any keen insights as to how the politics is going to play out.”

In a year that’s been characterized by record calm, Thursday’s two-point intraday jump in the VIX was enough to push it above the average level for 2017. The gauge, which uses options-trading data to measure implied volatility of S&P 500 stocks, still sits below the bull-market average of 18.3.

Major U.S. equity benchmarks slid from record levels, with losses widening after the Senate revealed that its tax plan would delay lowering the corporate rate until 2019.

Wall Street has been rallying on speculation the Trump tax cuts would benefit corporations and boost consumer sentiment. News yesterday that the Senate proposal would defer tax cuts until 2019 was not greeted with optimism and introduced doubt about exactly what, if anything, will eventually get passed. 

I would have to say that if there is a market that has broken out of a 25-year secular downtrend, and where the economic and political tailwinds are significant, it is in Japan. I get told all the time that Japan’s population is declining, but we are buying companies, not bodies, and the bottom line is that even with this declining population, earnings momentum is on the rise and profit margins in Japan are on an impressive expansion phase, and not nearly priced in, In fact, Japan is one of the few markets globally that is not trading at premium multiples relative to its history and is an under-owned market both globally and locally. 

A link to the full report is posted in the Subscriber's Area. 

Japan is one of the few major economies running both easy monetary and fiscal policy. That is contributing to asset price inflation which has resulted in the market breaking out of 25-year+ base formations. 

"The one part of the world which looks very good to me right now, a great turnaround story that's under-owned, is Japan. The Nikkei is breaking out," said Rosenberg said Friday on CNBC's "Trading Nation."

He added: "I think even a child could see that the 30-year secular downtrend has been broken over the course of the past couple of months."

The Nikkei 225, Japan's benchmark stock index, has soared nearly ten percent over the past three months. It's now up 15-percent so far this year. But it's still about 56 percent way from its all-time high hit in 1990.

According to Rosenberg, Japan has one of the few markets that isn't trading expensively to its historical price earnings ratio — noting "almost everybody else in the world is." 
 

Japan has been a disappointment for so long that when it breaks out to new highs it is tempting to think that this will be just another failed upside break. However there is an important point that should not be ignored when making that decision. It is one of the few countries in the world running simultaneously easy monetary and fiscal policy. Considering the magnitude of the Bank of Japan’s debt it needs to generate inflation if it is to ever have any hope of paying them back. That is also why it is buying stocks, as part ownerships in companies they represent income streams outside the taxation power of the government. 

"Globally, the BOJ’s continued policy accommodation should help cushion the blow from the Fed’s balance sheet normalization and the ECB’s expected tapering next year," said Frederic Neumann, co-head of Asian economics research at HSBC Holdings Plc in Hong Kong. "The BOJ will not be able single-handedly to keep rates low everywhere, but its commitment to continued monetary accommodation should restrain any possible global yield rise."

Indeed, a sharper divergence between its policy outlook and the rest of the developed world may aid the BOJ’s cause should the yen continue to weaken, helping to accelerate inflation by making imports pricier. The yen slumped to its weakest since July on Monday and shares moved higher as markets digested Abe’s landslide.

Abe’s decisive win on Sunday will embolden supporters of Abenomics, the prime minister’s signature economic policies centered around monetary and fiscal policy accompanied by structural reforms. It also increases the likelihood of BOJ Governor Haruhiko Kuroda being reappointed when his term comes up in April, according to Bloomberg Intelligence analyst Yuki Masujima, meaning the central bank’s policy framework won’t change.

Naohiko Baba, chief economist for Goldman Sachs in Japan, noted in a report on Monday that "the largest tangible result" of Abe’s commitment to the very ambitious inflation target has been to keep the yen weak and boost equities. The currency has declined more-than 20 percent since Abe took office in December 2012, while the Nikkei 225 Stock Average has roughly doubled.

 

It is arguable whether Abe has a mandate to change the pacifist constitution. However, the original reason he called the election was to receive approval for redeploying revenue from the increased sales tax for spending rather than paying down debt. Therefore, by holding his majority, he can claim resounding approval for his stimulus program. 

Machine learning is everywhere 
“Machine learning” repeatedly appears in the news, from the game of go to autonomous cars: what can those algorithms do for us in finance? 

Supervised learning and its pitfalls in finance 
In this first report in the series, we focus on supervised learning and note that while machine learning is very relevant to us, there are dangerous pitfalls, sometimes specific to the type of data we deal with. In particular, we examine penalized regression (lasso and elastic net), decision trees, and boosting – we also mention, in passing, support vector machines and random forests. 

Application to the Japanese equity market 
To make things more concrete, we try to use those algorithms to combine the investment factors in our database in order to build a stock ranking system for the Japanese market; this shows the limitations and pitfalls of traditional machine learning practices in finance. 

A link to the full report is posted in the Subscriber's Area.

Long Term Capital Management represented something of a genesis for quantitative strategies and their sophistication has been enhanced considerably since. The pace of adoption has accelerated in the last few years as the breadth of data from both conventional and unconventional sources has increased at an exponential rate and companies like Google and Baidu have demonstrated in real terms what is possible with these tools. 

I bought the Nikkei as it broke out of its range and it has been doing well on the back of an Abe victory which would lead to increased monetary spending and a lower yen, thus boosting the Nikkei.

I have read that very frequently pre-Japanese elections, the market runs up as people look to buy shares in industries that have been targeted by politicians for help, but that on the day of the election the market usually corrects. A buy the rumour, sell the news scenario. I wondered your thoughts on this. I know you are long the Nikkei and wondered if this was a potential long-term or short- term position, or what the charts are saying?

Also bought the US Tech 100 which broke out of its range but has been travelling sideways since it broke out and I wondered if that was not a good sign, since you usually talk about explosions waiting to happen either up or down. Best regards,

 

Thanks you this email and congratulations on grasping opportunities. 
 

Markets are suggesting that any snap election called by Japanese Prime Minister Shinzo Abe would take advantage of his opponents’ weakness and see him retain power.

A victory would ensure the continuation of Abenomics, the recipe of mega monetary easing, flexible fiscal policy and selective deregulation that’s helped Japan’s economy to its longest sustained expansion since before the global crisis. Abe, who’s expected to decide on the early ballot after returning from a U.S. trip, is capitalizing on growing public support for his management of the North Korean crisis.

 

We learned from Theresa May’s experience that being presumptuous about the ability of politicians to extend their majority can be a dangerous game. Nevertheless, Abe is a seasoned campaigner and one of Japan’s longest serving Prime Ministers. With a fresh mandate, he could help promote further reform. 

“By turbocharging supply and depressing demand, automation risks exacerbating China’s reliance on export-driven growth – threatening hopes for a more balanced domestic and global economy,” BI economists Tom Orlik and Fielding Chen wrote.
Pay gains are intact. Domestic manufacturing workers with a high-school education saw wages rise 53 percent from 2010 to 2014, according to China Household Finance Survey data cited by BI. 

“Increasing use of robots should be bad news for medium-skilled workers, especially those in sectors where routine work means scope for automation,” Orlik and Chen said. “Yet wage growth in China remains rapid, and if anything, medium-skilled workers conducting routine work are doing better than average.”

 

Technological innovation has led to the pace of development speeding up. It will not have escaped the attention of investors that the original Tiger economies were able to evolve economically much faster than the Europe or North America during the Industrial Revolution. More recently China has come from relative obscurity to be the world’s second largest economy. What used to take generations now takes decades and the pace of development is speeding up so that we may witness multiple iterations in our lifetimes. As much youngest daughter delights in telling me, she was born the same year as the iPhone. 

With a shrinking working population, Japan has record low levels of unemployment and the economy is poised to receive a boost once this lack of supply filters down to wage growth. But there are equities which can profit from the tight labour market according to Weindling; he invests in recruitment firms that provide permanent and temporary workers.

Suppliers Immune from Domestic Threats
While the population is ageing, Weindling points out that a Japanese company does not need a Japanese customer base to thrive.

“There is no reason why Japan should not continue to make things. Factory automation and robotics are not a threat to Japanese industrials in the way that they are to US companies – they are the solution to a dwindling workforce,” he says. “More automation is a good thing, and the larger industrials will continue to take market share. It is a multi-year, structural shift.”

That does not mean he backs the exporters of old, however. The international names which have long been synonymous with Japan are electronics firms and auto-makers; Toyota, Canon, Mitsubishi and even Sony are no-go areas for Weindling.

“No one buys cameras anymore, so why would I buy Canon,” he says. “We don’t own any of those household names. Their prospects are considerably lessened. Japan’s export market is no longer about cars and electronics, it is about condoms, baby milk, skin cream, medicine. Japan is known across Asia for high-quality products, reliability and high safety standards. These are the companies you want to be invested in.”

 

Japan is an increasingly popular tourist destination for Asian, particularly Chinese, tourists who come with well-defined shopping lists from WeChat personalities that tell them exactly what and what not to purchase. On my family’s visit to Japan in April there were a number of consumer items Mrs. Treacy was very eager to try based on reviews she had seen in Chinese social media. 

Ten years ago on Wednesday marked the start for many observers of the global financial crisis - a series of rolling credit shocks and bank crashes that led to the deepest world recession for a generation and a decade of slow growth and painful repair.

On Aug. 9, 2007, the European Central Bank flooded its money markets with billions of euros of emergency cash to prevent a seizure in the European banking system after France's BNP Paribas became the latest to shut down investment funds hobbled by a collapse of U.S. mortgage and asset-backed bond markets.

Serial bank collapses in Britain, the United States, Germany and elsewhere were to follow over the following 18 months. These culminated in U.S. investment bank Lehman Brothers being allowed to go bankrupt in September 2008, triggering a world financial panic, deep recession and eventual rescue package by the U.S. government, Federal Reserve and the rest of the G20 economic powers.

The number of articles pointing out this historical milestone has proliferated over the last week. It’s not particularly positive for sentiment because it reminds investors that everything comes to an end and often in a manner deleterious to one’s financial health. 

It's all a question of the tipping point: When do labor shortages become so acute that there's a scramble and employers both big and small have to pay up or risk, literally, running out of people? 

Izumi Devalier, head of Japan Economics at Bank of America- Merrill Lynch, thinks we've reached that point. "There have been many false dawns, so making the case this time can be quite difficult," she acknowledges over lunch. But, using an admittedly anecdotal example, she observes that famously high levels of service at Japanese restaurants are starting to slip subtly because of the gathering labor shortage. "People know that if they don't secure talent now, it's going to get harder and harder."

For those that want to stay in business, the need to retain staff will outweigh all others. Yamato Holdings Co. Ltd., the parcel delivery company with the cat-and-kitten logo that seems to be everywhere in Tokyo, is instructive. Faced with a shortage of drivers and efforts by competitors to poach those it did have, the firm raised its base rate for customers in April.

It took almost three decades, but what's important is that it happened. Fierce competition among delivery firms had made Yamato Transport wary of raising prices, but overworked and underpaid staff had better offers. Something had to give. Forty- seven thousand employees were subsequently compensated for unpaid overtime.

One might compare the shock to the system to the 1985 Plaza Accord, when Japan and West Germany agreed to let their currencies strengthen against the dollar. Among other things, Plaza accelerated the overseas expansion of Japanese corporations. Now companies need to make equally wrenching decisions about how best to deal with shrinking labor liquidity.

 

Japan is a petri dish for experiments on how to deal with a declining population without recourse to immigration. So far it has failed in stimulating inflation and while it may be necessary to pay employees more to ensure they are not poached, there is the additional question of where demand growth is to come from when such a large proportion of the population is in the latter stages of life. 

Hello Eoin! Thank you for all your hard work for us! You highlighted the Japanese Banks a few Days ago! Is there a Japanese Banks ETF or a closed end Bank fund, that you know of. Best regards. (an FM since 1988).

Thank you for your long support and this question which may also be of interest to other subscribers. There are two Japanese listed ETFs focusing exclusively on Japanese banks but I’m afraid I do not know of any others listed elsewhere whether ETFs or closed-end funds. 

The two Japanese ETFs are the Daiwa Topix Bank ETF (1615 JP) and the Nomura Topix Banks ETF (1612 JP).  

The diplomatic route that is being pursued by Donald Trump, as it was by his presidential predecessors, is not going to work. China is never going to take actions tough enough to force Pyongyang to give a “victory” to the US-led coalition.

Secondly, because the consequences of another war in Korea, even if brief and limited, would not be catastrophic for Americans... only for Koreans, and perhaps Japanese.

Thirdly, US willingness to act so decisively would convey the strongest possible message to a potentially much more dangerous would-be nuclear power, Iran, to forget the whole idea and behave.

Fourthly, foreign adventures are a classical method for national leaders to divert attention from political difficulties at home. “Trump, facing ever-expanding scandals, continually-low polling numbers, and even potential impeachment proceedings, may decide that a pre-emptive strike on North Korea is worth the costs and consequences,” Micah Zenko writes in Foreign Policy.

Much-respected analyst George Friedman of Geopolitical Futures concludes that the US continues to be “on the path to war.”

The US is not likely to unleash an attack until it has a casus belli, or a challenge from North Korea that it can point to as a defensible cause for going to war.

That hasn’t happened yet. But the situation could change very quickly if the US becomes convinced that the North has developed intercontinental ballistic missiles. Sudden falls in the South Korean and Japanese stock-markets would be an early warning of pending military conflict.

 

A link to the full report is posted in the Subscriber's Area.

North Korea currently has three US hostages which it is undoubtedly hoping will be a deterrent to a US military strike. That may prove to be a vain hope if it persists in pursuing development of an intercontinental ballistic missile. Simple maths would suggest the lives of millions of possible US casualties outweigh the near certain death of three. 

Details of this trade are posted in the Subscriber's Area.

Capital spending in Japan topped estimates during the first quarter of the year as the tightest job market in more than two decades drove investment in labor-saving technologies.

Highlights

Capital expenditure rose 4.5 percent in the first quarter of 2017 from a year earlier (estimate +4 percent).Corporate profits climbed 26.6 percent. Company sales rose 5.6 percent.

Key Takeaways

A moderate economic recovery and a labor shortage have created a favorable environment for business spending, prompting companies to invest in technology. Today’s figures will be used to revise first-quarter growth, with the result due to be released next week. The preliminary reading showed an annualized expansion of 2.2 percent.

Economist Views

* “Non-manufacturers are taking the lead” as they try to save manpower to deal with the labor shortage, said Takeshi Minami, chief economist at Norinchukin Research Institute. “That’s a good trend. It’s long been said that old production systems are weighing on productivity.”

* “The business-spending figure in the GDP report may be revised up slightly” after the data, said Hiroaki Muto, chief economist at Tokai Tokyo Research Center in Tokyo. “With corporate profits rebounding a lot, companies are probably making investments to renew their old facilities and equipment or to boost productivity.”

Other Details

* Spending minus software rose 5.2 percent from a year earlier (estimate +4.1 percent).

Japan is growing at a G-7 beating 2.2%. That’s not something we hear very often for a country that has been mired in deflation for what feels like forever. The fact it is occurring against a background of full employment and an increasing labour shortage suggests companies will be investing more in technology, automation and may as a last resort have to raise wages. 

If all goes well, the BOJ’s current policy framework may yet be sufficient to achieve the inflation objective. We’ll have to wait and see. If not, there are relatively few options available. The most promising possibility—should we get to that point—is more explicit coordination of monetary and fiscal policies. Monetary policy that is aimed at limiting the impact of fiscal expansion on the government’s debt could both make fiscal policymakers more willing to act and increase the impact of their actions. The BOJ may be reluctant to take such a step. In the possible future state that I am contemplating, however, there would be no real alternative other than to abandon the fight to raise inflation and, perhaps, even to accept a new bout of deflation. After such a long and valiant effort to end deflation and raise interest rates from their effective lower bound, that would be a most disappointing outcome.

Japan has had modest success with attempting to foment inflation but so far has failed to embed the belief prices are going to rise among the populace. The deflationary forces of technological innovation and lower energy prices have particular meaning for Japan quite apart from the fact the yield curve is flat and at nominally low levels. 

The 0.5% q/q growth in Q1 reflected positive contributions from both net exports (0.1pp) and domestic demand (0.4pp). Notably, the heavily weighted private consumption component increased 0.4% q/q, resulting in the large contribution for domestic demand. This reflected an upturn in spending on semi-durables, together with the recovery in durables since last year. Private consumption was also up for services, but down for non-durables. That said, the strength of consumption in the Q1 GDP data may largely reflect an upswing in demand-side data and slightly overstate the underlying trend, setting the stage for a slowdown in Q2.

In other areas of domestic demand, private capex increased 0.2% q/q (Q4: 1.9%), a second consecutive gain. Also, housing investment rose 0.7% q/q, sustaining positive growth. Meanwhile, public fixed capital formation (public investment) fell 0.1% q/q in Q1 (Q4: -3.0%), a third consecutive decline. However, we expect such investment to turn positive in Q2 as the effects of the FY16 second supplementary budget materialize. At the same time, real exports increased 2.1% q/q and real imports rose 1.4% q/q. For real exports, this marked a third consecutive quarter of growth (Q3 16: 1.9%; Q4 16: 3.4%). This reflects the ongoing recovery in demand from overseas, especially Asia.

 

European and US politics as well as the meltdown in confidence in Brazil’s administration are making headlines. In fact they are obscuring the more important news that global growth is generally on an upward trajectory and this has been the case for at least 12 months already. The Japanese economy has been in and out of recession on a number of occasions over the last few years but the uptick in activity in Asia is having a positive influence in conjunction with efforts to stoke domestic demand. 

“The mindset is still quite cautious about inflation expectations, but I’m quite sure that with continuous accommodative monetary policy, supported by fiscal policy, we’d be able to eventually raise wages and prices significantly,”

CNBC cites BOJ Governor Haruhiko Kuroda in interview.

* Projected growth rate of 1.5% “not great” but it’s well above medium-term potential growth rate

* Means output gap to shrink and become positive while labor market continues to tighten

* Wages, prices would eventually rise to achieve 2% inflation target around fiscal 2018

* Yield curve control “has been functioning quite well”

* 10-yr JGB target should, for the time being, be maintained around 0%

* Acknowledges that “headline inflation has been quite slow to adjust upward” in part because of weakness in oil prices

 

Since its bubble burst in the late 1980s Japan has been attempting to combat deflation and despite its best efforts failed. The big question is whether this was because they were not aggressive enough early on in forcing the banking sector to write down large bad loan books, or was it because their bust occurred in one of the greatest disinflationary periods in modern history and no matter what they did they could not have fomented inflation? I suspect the answer lies somewhere in between. 

For the first time since 2010, the global economy is enjoying a synchronous recovery (see chart). The developed markets’ (DM) private sector is exiting deleveraging after several years of slow growth due to a focus on balance sheet repair and, after four years of adjustment, the emerging markets are in a recovery mode. These trends create a positive feedback loop. Indeed, the DM economies account for 60% of emerging market (EM) exports, so as their real import growth accelerates, EM exports are rebounding. What’s more, an improving EM outlook reduces DM disinflationary pressures. 

How sustainable is this recovery? Typically business cycles end with macrostability risks (price, external and financial) spiking, forcing policymakers to tighten monetary and/or fiscal policy. In this cycle, considering that emerging markets inflation and current account balances are moving toward their central banks’ comfort zones, it is unlikely that macrostability risks will surface soon. Moreover, the emerging markets now have high levels of real rate differentials vis-àvis the US, providing adequate buffers against normalization of the Federal 

DEVELOPED MARKET RISK. In our view, the key risk to the global cycle is apt to come from the developed markets— most likely the US, considering that it is most advanced in the business cycle. Moreover, the US tends to have an outsized influence on the global cycle, particularly the emerging markets. While price stability features prominently in debating the monetary policy stance of any central bank, financial stability is clearly emerging as an equally important factor.

How will it play it out? For insight, we can look at history. The late ’60s saw fiscal expansion at a time of strong growth and low unemployment. In the mid ’80s, the US pursued expansionary fiscal and protectionist policies in an improving economy. We look at similarities and differences versus today, analyzing asset class performance by fiscal deficit and unemployment quartiles.

To that end, private-sector leverage has picked up modestly in the US. In fact, the household-sector balance sheet, which was the epicenter of the credit crisis, had been deleveraging until 2016’s third quarter. Moreover, the regulatory environment has been relatively credit-restrictive. Hence, we see moderate risk to financial stability. However, risks could rise, considering that monetary policy is still accommodative, and particularly so if the administration eases financial regulations. Price stability is a critical risk, too—especially since the core Personal Consumption Expenditures Index inflation rate is close to the Fed’s target and US unemployment is around the rate below which inflation could accelerate. Reflecting this, we expect the Fed to hike rates six times by year-end 2018 (see page 3). We expect other major DM central banks to take a less dovish/more hawkish stance

A link to the full report is posted in the Subscriber's Area.

The MSCI World Index broke out to new all-time highs in March and continues to extend that breakout. There is no denying that the Index is heavily weighted by the USA but it has been a generally firm period for global stock markets as economic growth figures pick up against a background where interest rates are still relatively accommodative. 

Details of this trade are posted in the Subscriber's Area. 

I wonder if you could please analyse why the historic charts of Japan's main equity market are so divergent? 

As you know, the Tokyo market reached its "bubble era" peak in Jan. 1990 at 38,564 but has since recovered to around 19,063. 

The Topix bank index peaked at the same time at 1,480 but is still languishing at a fraction of that level, 182.64 today. 

The Topix 2nd Section index on the other hand is now at an all-time high from its peak of 4,500 reached in 1990 to approaching 6,000. 

Normally the banks are the lead indicator but Japan's banks underwent immense restructuring so I can understand why they have languished but the discrepancy between these charts seems huge.

 

Thank you for this email which raises important points worth covering with regard to Japan’s primary stock market indices. 

The Topix is also known as the Tokyo Stock Price Index. It is a free-float adjusted market capitalization-weighted index and comprised of all 1997 shares in the 1st Section of the Tokyo Stock Exchange. 

Here is where some of the idiosyncrasies of the system begin. The 1st Section is supposed to comprise all of the large companies and the 2nd Section holds whatever is left. However, at least 80 of the 567 companies in the 2nd Section have larger market caps than the smallest company in the Topix which highlights the fact that the weightings are not actively managed.

Automobile, beer and cosmetics firms have slashed young-adult advertising and market to retirees instead, says Yohei Harada, head of the youth-marketing unit at Tokyo advertising agency Hakuhodo Inc. “The role of parents and children is getting reversed, where the parents from the bubble generation still act like children and want to buy the fancy car, while their children in the post-bubble generation worry about their parents’ spending,” he says.

Takashi Saito, a 33-year-old unmarried entrepreneur, was living in group apartment in Tokyo in 2015 when he decided to start a business. His idea: an online clothing-rental company for women who want a varied wardrobe but don’t want to pay for it. For $45 a month, clients rent three articles of clothing at a time, which they can return for others when they like.

Mr. Saito thought it would be easy to get a loan because Japan’s low-rate policies are meant to spur banks to lend more to small businesses. It wasn’t.

He asked Japan Finance Corp., a state-owned institution set up to lend to small businesses, for $200,000. After much haggling, he got less than $50,000. A year later, as the business grew, he asked for more. He was rejected. Japan Finance Corp. declined to comment.

Bank analysts say Japanese lenders have become more conservative, particularly with startup companies that have no collateral, because low rates cut into profits. In the 11-months after Japan’s rates went negative last year, Japan Finance Corp.’s loan portfolio shrank. 

 

Negative interest rates are sharply deflationary and central banks are finally coming to that realisation after an embarrassing foray last year. The Bank of Japan was the most visceral advocate of the policy and has been forced to backtrack. The commitment to holding JGB yields close to but below zero is a reflection of fears about refinancing costs following a splurge on new debt issuance but even that appears to have been abandoned with the yield currently at 0.05%. 

Output, new orders, new export orders, stock purchases and employment all grew at a faster pace than they did in January.

As lead indicators, the strength in new orders — both at home and abroad — bodes well for activity levels in the months ahead.

An increase in order backlogs, along with a faster decline in inventory levels, also points to a strengthening in activity levels.

“Encouragingly, with backlogs of work accumulating for the first time in 14 months, the added pressures on capacity should ensure growth will be maintained at a solid pace during at least the first half of this year,” said Samuel Agass, an economist at IHS Markit.

“Subsequently, business confidence was at a survey-high.”

That’s good news, and suggests the positive momentum in the global economy may have continued after a strong start to the year.

Despite the fact the Yen has spent the last few months strengthening, in what was a steady reversion back towards the mean, the fact it is trading considerably below where it averaged in the last decade is a broad positive for the Japanese market.  

Dividends are “being raised relentlessly,” says Price Value Partners? Tim Price. Incredibly, some international analysts say Japan is now an equity income play, after decades when its companies were notorious for neglecting their shareholders.

Whereas “the balance sheets of US companies are groaning with years of accumulated debt, Japanese balance sheets are now the strongest in the world,”

Tim says. Stock buybacks are now accelerating, and unlike the US, where buybacks are “debt-fuelled,” those in Japan are funded out of cash. John Seagrim of CLSA says: “The deep value opportunities in Japan are almost endless,” with 1.480 listed companies trading below their tangible book values.

For the first time in years, the Japanese stock market now has strong domestic support. Jeffrey Gundlach says the government is encouraging it via three sources of “pretty much automatic buying” at an annual rate in excess of 5 per cent of total market capitalization. The central bank is buying ¥6 trillion (about $53 billion) worth of equities every year, corporate Japan is investing about the same amount, the state pension fund ¥5 trillion, private investors about ¥4 trillion.

 

A link to the full report is posted in the Subscriber's Area.

Japan posted its largest current account surplus in a decade in the 2016 suggesting the country is benefitting low oil prices, the weakness of the Yen, improving global GDP growth and tourists from neighbouring countries flocking to its shores.

As for exchange rates, which are important for Japanese stocks, US long-term interest rates warrant attention. If the 10-year Treasury yield rises to 3%, we think the yen will depreciate to Y120-125/$. In this case, expectations for the Bank of Japan (BOJ) to change its monetary policy framework would probably emerge. We forecast Japanese corporate earnings will recover sharply from 2H FY16 and significant upgrades to consensus earnings estimates are likely, due in part to yen depreciation. With free cash flow to equity expanding rapidly, shareholder payout capacity should increase.

Outlook for Japanese stocks: Against the backdrop of interest rates starting to increase worldwide in July 2016 and US long-term interest rates and the dollar rising since Mr. Trump’s victory in the presidential election, global investors have been shifting funds from bonds to equities and taking a more positive stance toward Japanese stocks. We think funds will flow into the Japanese stock market. Assuming Y115/$, we forecast TOPIX EPS of 94 for FY16, 108 for FY17, and 120 for FY18. Based on this, we expect the Nikkei Stock Average to reach 21,000-21,500 by end-2017. If the yen weakens to Y120/$, we forecast the index to be around 22,500.

A link to the full report is posted in the Subscriber's Area.

The Yen is a powerful arbiter of investor interest in Japanese stocks. Despite the fact that many of the country’s largest exporters have relocated to cheaper locales there are still a lot domestic businesses that benefit from the competitive advantage of a weaker currency. 

Additionally the low interest rate environment and abundant liquidity that accompanies quantitative easing in a considerable number of jurisdictions means hedged access to nominal price movements have never been cheaper.

A third supplementary budget is on the drawing board to reconcile current-year spending and revenue figures, according to government officials familiar with the talks who asked not to be named per ministry policy. As to whether it goes beyond being a clerical package and takes on stimulus measures, that’s a function of what happens with politics, they said.

A policy shift at the Bank of Japan and doubts about how much more Abe will accomplish in structural reforms is likely to increase pressure for a fiscal fillip.

"We can’t put any more pressure on monetary policy, so the government will have to do more with fiscal spending," according to Koya Miyamae, an economist at SMBC Nikko Securities Inc.

Yet tax revenue for the 12 months ending March 31 is likely to be lower than originally expected, as economic growth has been weaker than initially forecast, and government debt is already about 2.5 times the size of the economy.

Japan’s budget deficit was 5.8 percent of gross domestic product in 2014, compared with 3.9 percent in the U.S.

Asked about the need for another stimulus package this fiscal year, LDP Secretary General Toshihiro Nikai said last month it was "one option," according to Kyodo News.

Trump has indicated he’ll spend $550 billion on infrastructure, with his plans forecast to add more than $5 trillion in debt.

Satoshi Fujii, an adviser to Japan’s Cabinet Office, advocates looking at more fiscal stimulus as part of efforts to escape deflation. He said in a telephone interview on Nov. 11 that a third extra budget this year and a large initial budget next fiscal year may help Japan "fit very well with Trump’s policies."

By marrying itself to a target for JGB yields the Bank of Japan has made its monetary contingent on the market. Therefore the government is now under more pressure to stimulate through both spending and reform in order to revitalise growth. A weaker currency could certainty play a part of that strategy. 

The Bank of Japan’s two-day policy meeting ends Wednesday, with investors anxiously awaiting the outcome of a comprehensive policy review that may set the future course of Governor Haruhiko Kuroda’s monetary stimulus program.

The biggest questions for many are whether the BOJ is willing to increase the record scale of its asset purchases or to cut its negative interest rate further. By doing neither at recent meetings, even as some consumer prices were falling, Kuroda and his board have fueled speculation that the BOJ’s main policy tools are running up against their limits. Taking little or no action today risks reinforcing that view.  

A narrow majority of economists surveyed by Bloomberg expect the BOJ to announce expanded stimulus. Most of the rest forecast action in November, December or next year, while a few predict no additional easing at all. Any weakening of the BOJ’s commitment to push further with stimulus is likely to force the yen higher and weigh on stocks, while a boost from Kuroda may soften the currency and underpin Japanese shares.

 

The essence of the Bank of Japan’s commitment to hold JGB yields at 0% is that it is willing to monetise as much debt as is needed to stimulate asset price inflation in the wider economy which it hopes will lead to economic growth. 

Hello I read your analysis about the Topix bank index, for the first time I don't really agree with you. The bank of Japan is doing something new and it could push the Topix banks index up. I cannot attach graphs here to this message, but if on Bloomberg you compare the Topix bank index (or any bank index) to the difference in 30 year and 10 year JGB yields the correlation in the last 2 years is almost perfect. I believe they intend targeting yields to keep the curve ripid to help the banks. The same thing will probably happen in the Eurozone as they soften some capital rules as well, so I think the bank indexes should be watched even if only on a relative basis (bank indexes should outperform general indexes like sp500 and DAX and the yield curve become more ripid in Eurozone Japan and US), sorry I can't attach my Bloomberg graph. I hope at the chart seminar in London you can let me understand why you do not consider correlations such as these. They are not long term correlations, but are valid in a zero bound environment.

Thank you for this email highlighting some key measures of how the financial sector has reacted to the Bank of Japan’s stimulus policies. I look forward to covering these topics with you in person in London this November. It’s looking like an interesting group of delegates will be in attendance. 

The BOJ plans to maintain 10-year yields in the nation at around the current level of close to zero, it said Wednesday, giving it scope to keep loosening policy to revive growth and inflation, while limiting the negative impact on financial companies’ earnings. The BOJ faced a backlash after first deploying negative rates in January, with Governor Haruhiko Kuroda acknowledging it cut into the profits of lenders and insurers by driving long-term yields lower. Next, investors will be looking to the U.S. for any signals regarding the timing and pace of future Fed hikes, with all but four of 102 economists surveyed by Bloomberg predicting policy makers will hold off from raising interest rates.
     
“Central banks are acknowledging that excessively negative rates are damaging to bank profitability,” said Michael Hewson, a market analyst at CMC Markets in London. “There is a perception that maybe what the Bank of Japan is looking to do could be a template for the European Central Bank and potentially the Bank of England.”

Monetary authorities will continue to command attention on Thursday with speeches due from the new governor of the Reserve Bank of Australia as well as the heads of the European Central Bank and the Bank of England. In addition, central banks in countries including New Zealand, Norway and South Africa have policy decisions due that day.

The Topix Banks Index collapsed in January following the announcement of negative rates. While we might look back in a few years and wonder what on earth central banks were thinking, it is now increasingly evident that they are beginning to accept it is a bad idea. Negative rates represent a major headwind for bank profitability and are inherently deflationary, which is the exact opposite of the long-term objectives of central bank policy 

It’s been a “no-brainer since forever,” said Sekiai, a money manager at Tokyo-based DIAM Co., which oversees about $166 billion.

That truism is now a thing of the past. Last month, yields on U.S. 10-year notes turned negative for Japanese buyers who pay to eliminate currency fluctuations from their returns, something that hasn’t happened since the financial crisis. It’s even worse for euro-based investors, who are locking in sub-zero returns on Treasuries for the first time in history.

That quirk means the longstanding notion of the U.S. as a respite from negative yields in Japan and Europe is little more than an illusion. With everyone from Jeffrey Gundlach to Bill Gross warning of a bubble in bonds, it could ultimately upend the record foreign demand for Treasuries, which has underpinned their seemingly unstoppable gains in recent years.

“People like a simple narrative,” said Jeffrey Rosenberg, the chief investment strategist for fixed income at BlackRock Inc., which oversees $4.6 trillion. “But there isn’t a free lunch. You can’t simply talk about yield differentials without talking about currency differentials.”

 

With interest rates so low there is very little cushion left in a foreign investment dependent on harvesting low yields. Therefore it is unsurprising that Japanese and Euro denominated investors are losing money on investments in Treasuries. With Euro/Dollar volatility at 18-month lows, the low return for Euro investors on investing in Treasuries is truly a testament to how low rates are.

“The opportunity is huge,” said Jasper Cheung, president of Amazon Japan. “We have already increased the selection that we can export by the millions over the last several weeks.”

Chinese shoppers are looking for authentic Made-in-Japan products, spooked by tainted baby milk and fake merchandise proffered on web stores in China. While that’s helping to drive an influx of shoppers to Japan -- 3.08 million Chinese tourists have visited the archipelago so far this year, up 41 percent -- it’s also boosting demand for Amazon.co.jp, Wandou and other web outlets featuring Japanese goods.

Rakuten Inc., the Japanese online store, also lets people shop for stuff from Japan in Chinese, as well as in Korean and English. Amazon’s Japan website has been available in English for years.

The new iteration of Amazon Japan’s shopping portal, in simplified Chinese, offers millions of products with more coming, the company said. Consumers in Asia’s biggest economy are demanding access to authentic brands and quality, from clothing and cosmetics to baby products and health goods. That’s why Costco Wholesale Corp. has a shop on Alibaba’s Tmall.com, while Macy’s Inc. and other U.S. retailers are tapping into China’s dominant online-payments system by accepting Alipay on their sites.

 

For billions of new consumers entering the middle classes their first taste of consumerism is likely to be via their mobile phones where they are aggressively marketed to via Wechat, Facebook, Instagram and a host of other social media sites. That puts dominant online marketplaces like Amazon, Alibaba, Ebay and Rakuten in a favourable position to compete for their business and China represents a major battleground. Uber’s experience in China highlights the difficulty of doing business in that country where one is competing with a domestic copycat operation. Amazon’s strategy of building out its Japanese operation may act as a hedge to domestic Chinese operations where it competes directly with JD.com and Alibaba.  

I very much enjoyed last Friday's and yesterday's audio recordings. I think too that we are close to entering the final phase for this bull run notwithstanding a potential pull-back first. The expected further liquidity injections by the global central banks has intensified the hunt for yield. Emerging markets should do well as they offer both yield and the potential for large capital gains. Incidentally, if as David suggests, the $ index (developed markets) rises towards 100 again, will the EM currencies also weaken? Or as they have already fallen substantially in recent years, the dollar's rise against the developed market currencies will not impact EMs much? Your thoughts would be appreciated. I'm also interested in your views on $/Yen on a medium term basis.

 

Thank you for your kind words and I agree the strength of the Dollar is a major consideration in assessing the outlook for global markets.

It is worth considering that the Dollar Index is composed of Euro (57%), Yen (13.6%) and Pound (11.9%), none of which one is likely to consider a strong currency at present. 

Finance Minister Taro Aso signaled that Japan’s government won’t intervene to stem the yen’s strength without due consideration, saying the markets have already somewhat taken into account the potential impact of a vote in favor of Brexit.

“Speaking of FX intervention, we won’t do it lightly,” Aso said at a press conference in Tokyo on Tuesday. “The G-7 and G-20 have agreed that abrupt moves are not desirable and we aim for stability. We will take action in line with that agreement.”

Aso’s comments came as the yen has surged more than 5 percent versus the dollar in June as global markets await the outcome of Britain’s June 23 referendum on European Union membership. The vote and its effect on the global economy has boosted the yen’s demand as a safe-haven currency.

The finance minister said the market has already taken into account Brexit to some degree, limiting upward pressure on the yen. Aso last week voiced strong concern about one-sided, abrupt and speculative moves in the foreign exchange market. The yen traded at 104.03 per dollar as of 12:49 p.m. in Tokyo.  

 

Negative interest rates inhibit the BoJ’s ability to weaken the currency since it is inherently deflationary and therefore reduces rather than increases the quantity of currency in circulation. The question therefore is at what point the strength of the Yen is likely to pressure officials to try something new? 

“100 is a serious risk that’s growing by the day,” said Cliff Tan, the East Asian head of global markets research at Bank of Tokyo-Mitsubishi UFJ in Hong Kong. “Both domestic and foreign investors are giving up on the idea the government can do much to revive Japan.”

The yen’s jump comes after about a quarter of analysts surveyed by Bloomberg had predicted additional BOJ stimulus today. More than half forecast action at the July meeting.

“Further easing is still on the cards,” said Kohei Iwahara, director of economic research at Natixis in Tokyo. “The yen is already stronger than most companies feel comfortable with, and a dovish Fed could strengthen the yen further.”

Projections released by the Federal Open Market Committee Wednesday showed the number of officials who see just one rate increase in 2016 rose to six from one in the previous forecasting round in March. The U.K.’s June 23 referendum was also “one of the uncertainties that we discussed and that factored into” the decision, Fed Chair Janet Yellen said.

 

The Japanese remain committed to their negative interest rate policy, the net effect of which is to remove currency from the system rather than add it. To increase the bank’s purchases of bonds while they are at negative yields would ensure it makes a loss. It would appear the BoJ is not yet ready for outright helicopter money but that could change at any time as the impact of a stronger currency takes a toll on the economy.  

Expectations for higher rates this summer tumbled after the jobs report. Based on Fed funds futures, traders are now pricing in a 31 percent chance of a Fed boost by July, down from 55 percent earlier, while odds for a June hike have fallen to 4 percent from 20 percent.

The selloff was deepest among banks and insurers, with all but 15 of 92 members in the S&P 500 Financials Index retreating. Goldman Sachs Group Inc. and JPMorgan Chase & Co. fell at least 2.1 percent, while brokerages E*Trade Financial Corp. and Charles Schwab Corp. sank more than 5 percent.

Banks have been labouring under tight margins with the low interest rate environment. The potential for interest rates to rise would help improve the prospects of profiting from money market funds and other short-term interest rate products they offer and would have increased margins on loans. With sentiment once more ebbing and the potential for a series of rate rises currently looking less likely, that source of profitability looks a little more distant. 

But a negative interest rate is just a tax on the banks’ reserves. The tax has to be borne by someone:

The banks can choose not to pass it on and just have lower after-tax profits. This will depress the share price of banks and weaken their balance sheets by having lower equity values.

The banks can pass the tax onto depositors by paying a lower interest rate on deposits or charging them fees for holding the deposits. In either case, depositors have less income to spend on goods and services.

The bank can pass the tax onto borrowers by charging them a higher interest rate on a loan or higher fees for processing the loan. In either case, it is more costly to finance purchases of goods and services by borrowing.

None of this sounds very “stimulative” for consumer spending. But then, no tax ever is.
Negative Interest Rates in Other Countries

What has happened so far in countries that have tried negative interest rates? The figures below provide answers. As seen in the first chart, bank stock prices have definitely taken a hit. After initially continuing their downward trends, interest rates on mortgages have now risen in Germany and Switzerland (the second chart). Banks have been very reluctant to charge negative deposit rates for fear of a backlash from customers (the third chart).

At the end of the day, negative interest rates are taxes in sheep’s clothing. Few economists would ever claim that raising taxes on households will stimulate spending. So why would they think negative interest rates will?

 

The ECB announced a two-step shuffle, when it implemented its negative interest rate policy, in order to mitigate the effect it would have on the banking sector. However there is no getting around the fact that negative interest rates are going to be borne by someone and that consumers are unlikely to benefit in that scenario. 

“We’ve had the knee-jerk reaction to no change as the majority expected some form of action,” said Cameron Duncan, Sydney-based co-head of income strategies at Shaw and Partners, which manages the equivalent of $7.6 billion. “In, hindsight, it’s probably consistent that they haven’t done anything because they eased three months ago.

There’s typically a lag in terms of response to that sort of easing. It’s the Bank of Japan and they’re pretty conservative and they are still waiting to see what the impact of that is.”

Goldman Sachs Group Inc. and HSBC Holdings Plc were among those expecting the central bank to add to ETF buying. Goldman Sachs estimated the BOJ would expand annual purchases to 7 trillion yen, while HSBC predicted an increase to 13 billion yen.

The central bank’s decision to forgo additional easing this time hasn’t deterred some from expecting more stimulus in the future. It’s inevitable that economic growth and inflation will take a downturn and given the outlook for a stronger yen, the BOJ will likely boost stimulus eventually, SMBC Nikko Securities Inc.’s chief market economist Yoshimasa Maruyama said.

Driven to Ease
“The situation the BOJ is in won’t change for the better because of its decision today,” Maruyama wrote in a note to clients. “It’ll be driven into easing further sooner or later.”

The Topix is down 13 percent this year, making it the worst performing developed market in 2016, after starting 2016 tumbling into a bear market on worries over oil prices and slowing global economic growth. The measure has climbed back 12 percent from a Feb. 12 low, bolstered by a recovery in oil prices and signs of stabilization in China’s economy.

 

“If you’re going to go, go big” was something the BoJ appeared to have understood when it adopted the QE program that sent the Yen down more than 50% and ignited a major run in Japanese stocks between late 2012 and early 2015. Since the middle of last year the commitment to doing everything necessary to ignite inflation has waned. The wait and see attitude adopted of late suggests a lukewarm commitment to reform and expansion. 

I always enjoy your service very much. But todays comment & audio was extraordinary it deserves to be a classic. Congratulations. I now have a question: You had been very bullish on Japan last year, especially on hedged instruments on the Japanese market. It does not seem to be going that way recently. Do you think it is the right time to lighten hedged Japanese equity positions?

Thank you for this question which may be of interest to other subscribers. The correlation between the weakness of the yen and the relative strength of the Japanese stock market was a powerful bullish phenomenon until the middle of last year when the Yen began to find support. Since then the currency has strengthened from ¥125 to ¥109 and what had been a tailwind turned into a headwind for the stock market. 

Big companies across all industries plan to cut capital expenditure by 0.9 percent this fiscal year, more than the median economist estimate of 0.7 percent.

Large manufacturers based their plans on an assumption that the yen will average 117.46 per dollar over the next 12 months, a level more than 5 yen weaker than its rate Friday.

“The data has worsened overall, regardless of industry sector and company size,” Koya Miyamae, an economist at SMBC Nikko Securities in Tokyo, wrote in a note. “There’s especially an indeterminate sense of concern for the outlook." 

Strategists are turning cautious after the best month for the Topix since October helped pare the first quarter’s losses.

The Japanese benchmark started 2016 by tumbling into a bear market as global shares plunged, and has been lagging its peers amid the global recovery. The Japanese gauge is the second-worst performing developed market this year, as the yen has weighed on exporters’ earnings prospects.

 

The Dollar broke downwards against the Yen in January and encountered resistance in the region of the trend mean a few weeks later. Since the weakness of the Yen was one of the platforms on which the bullish case for Japanese equities was predicated this represents a headwind for investors. A sustained move above the trend mean would be required to begin to suggest a return to Dollar dominance. 

The yen has gained for a third week, the longest streak since the five days ended Sept. 4. That move has come even after Bank of Japan Governor Haruhiko Kuroda unexpectedly adopted negative interest rates at the end of last month, sparking speculation the central bank may intervene to arrest the currency’s gains.

Japanese authorities will find it “very difficult” to step in should the yen’s appreciation accelerate before Group-of-20 finance ministers and central bankers meet next weekend in Shanghai, said Mansoor Mohi-uddin, senior markets strategist in Singapore at Royal Bank of Scotland Group Plc.

The premium for options protecting against gains by the yen, compared to those insuring against a loss, rose to near the highest since 2010, three-month risk reversals show. Dollar- yen’s 14-day relative strength indicator is, however, close to 30, a level that some traders view as a signal the currency has reached extreme levels and may reverse.

Forecasters are also unconvinced that yen strength will be sustained. Goldman Sachs sees the yen weakening to 120 per dollar “in the near term,” and 130 by year-end, Goldman analysts led by chief currency strategist Robin Brooks wrote in a note to clients Friday.

The median of more than 50 estimates compiled by Bloomberg calls for the yen to slump to 120 per dollar by the end of March, and to 123 by year-end.

 

Japan has negative interest rates and a central bank with an unabashed mandate to devalue the currency and yet the Yen is receiving safe haven flows. Yes, Japan still has a current account surplus but deleveraging is a more important consideration. 

Bank of Japan Governor Haruhiko Kuroda sprung another surprise on investors Friday, adopting a negative interest-rate strategy to spur banks to lend in the face of a weakening economy.

The move to penalize a portion of banks’ reserves complements the BOJ’s record asset-purchase program, including 80 trillion yen ($666 billion) a year in government-bond purchases, which was kept unchanged at the board meeting. By a 5-4 vote, Kuroda led his colleagues to introduce a rate of minus 0.1 percent on certain excess holdings of cash.

Long a pioneer in adopting unorthodox policies to tackle deflation and revive economic growth, the BOJ is now taking a page out of European policy makers’ playbooks in the goal of stoking inflation. The yen tumbled after the announcement, which came after Kuroda just last week rejected the idea of negative rates.

“This clearly shows the BOJ wanted to weaken the yen and raise the price of import goods and boost inflation,” said Daisuke Karakama, an economist at Mizuho Bank in Tokyo. “We don’t know this negative rate policy will be good for the economy in the end,” he said, adding that success in Europe doesn’t guarantee the same for Japan.

 

JGB yields plunged on today’s news since a yield of 0.1% is still better than receiving negative 0.1% from deposit. In addition to continued BoJ purchases, in line with its quantitative easing program, this has sent yields to record lows with little prospect for significantly higher levels while the policy persists. 

“The ground right now is so unstable, and there’s so much anxiety,” said Ayako Sera, a Tokyo-based market strategist at Sumitomo Mitsui Trust Bank Ltd., which has $453 billion under management. “We saw an early rally, but people are just bottom- fishing. There are no real reasons to stem drops right now.”

Following a steep 20% decline since late November, it is perhaps not so surprising that sentiment towards the Japanese stock market is despondent at best and dismal at worst. The simultaneous strength of the Yen is symptomatic of deleveraging as carry trades were unwound and has less to do with domestic considerations. However it has been a headwind for stocks. 

Following yesterday’s disappointing start to the year and against a background of heightened geopolitical tension, weakening performance in emerging markets and fears about a paucity of earnings growth I thought it would be an interesting time to look at the performance of what have traditionally been viewed as safe haven assets. 

Dear friends, I wonder if Fanuc would still be a good idea if this scenario develops. Best wishes for all of you

Thank you for this email in reference to the piece I posted on December 24th discussing JP Morgan’s view the Yen would potentially strengthen to ¥110 this year. The size of the Bank of Japan’s balance sheet continues to trend consistently higher.  Its announcement in mid-December that it was not going to accelerate its printing policy resulted in a sharp pullback for stocks but it did not result in a sustained drop below ¥120. 

“Different from past episodes of the yen carry trade, this time the major sellers of the yen are Japanese," he said, referring to a strategy where investors borrow yen cheaply to invest in higher-yielding nations. “Japanese will need to unwind those positions eventually. The yen is no longer the ideal funding currency.”

Funding carry trades in yen lost money against every major currency in the second half except the New Zealand dollar.

Neither the BOJ nor politicians want additional weakness, as wage gains have failed to keep pace with surging food prices, squeezing consumers, according to Sasaki. The yen drop also spurred a record number of bankruptcies among small- and medium-sized businesses dependent on imported materials. JPMorgan sees its benefits as exaggerated.

“The economy is not driven only by the foreign-exchange rate,” he said. “If the growth momentum is strong, I think the Japanese economy can overcome it.”

 

Having trended higher in a reasonably consistent manner from late 2012, the Dollar lost momentum over the last year against the Yen   The Bank of Japan disappointed traders earlier this month when it demurred from accelerating its easing program. As a result the Dollar dropped back to test the region of its trend mean and will need to find support in the region of ¥120 if medium-term potential for continued higher to lateral ranging is to given the benefit of the doubt. 

“Investors are losing hope because the amount isn’t big,” said Ayako Sera, a Tokyo-based market strategist at Sumitomo Mitsui Trust Bank Ltd., which has $453 billion under management.

“At first it seemed like the BOJ was progressing with easing, but when you look at what’s inside that, it’s nothing much.

They’re focusing more on qualitative, rather than quantitative, easing.” The central bank kept its main target for monetary stimulus of 80 trillion yen ($650 billion) a year in asset purchases unchanged, indicating confidence in the economy after data from capital spending to business confidence and unemployment exceeded expectations. The announcement follows this week’s decision by the Federal Reserve to raise U.S. interest rates for the first time in almost a decade.

The central bank said it will extend the average maturity of holdings of Japanese government bonds to between seven and 12 years, and also boost the amount it can purchase in
Japanese real-estate investment trusts to 10 percent from the current 5 percent limit. It will also extend the time frame for selling the shares it purchases by five years, with the new deadline for completion being March 2026. The new ETF program will start from April, when the BOJ plans to resume selling shares it had purchased from banks.

“The BOJ is slightly expanding areas related to ETF and bond holdings, but investors are starting to see that the changes aren’t as big as they thought,” said Hiroaki Hiwada, a Tokyo-based strategist at Toyo Securities Co. “Investors were buying on hope. People are disappointed after looking at the details closely.”

 

Quantitative easing has a diminishing return the longer a central bank persists with it because as asset prices increase more capital is needed to influence the same percentage gain. When the ECB announced it was not expanding its program at the last meeting the Euro surged from its lows. Today’s BoJ announcement that they are not accelerating their program has had the same effect.

Euro per 1 US Dollar overlaid with the Euro Stoxx Index – The Euro STOXX reacted positively to the Euro’s devaluation earlier this year and the currency’s recent strength represents a headwind for the Index. It has held a progression of lower rally highs since March and a sustained move above 366 would be required to question the medium-term supply dominated environment. 

Many economists including those at UBS Group AG and Mitsubishi UFJ Research and Consulting Co. retain the view that economic fundamentals remain the most likely trigger for the BOJ. Some also note, as the central bank itself has, that inflation will emerge as labor shortages propel wages higher.

Until 2012, the yen was trading at about 80 to the dollar, weighing on profits for such companies as Toyota Motor Corp. and Honda Motor Co.

Kuroda can’t afford to have Japan’s large companies cut their earnings forecasts as he has cited high business profits as a source of more investment and wage increases, said JPMorgan’s Kanno.
Large manufacturers expected the yen to be 117.39 on average for the year through March, taking it close to potential trigger levels suggested by some economists. The median of market forecasts compiled by Bloomberg is for the yen to be at 122 at the end of this quarter.

Economists were almost evenly split on the likelihood of more stimulus before the Oct. 30 meeting at which Kuroda and his policy board stood pat. When the BOJ last increased its asset purchase program in October 2014, only three of 32 analysts surveyed by Bloomberg forecast the move.

 

The Yen has been one of the primary tools used by the Bank of Japan to enact is reflationary program. Everyone got the message back in 2012 when the stock market took off in an inverse response to the Yen’s decline. 

The US Dollar lost momentum against the Yen from early this year and failed to hold the move to ¥125 in June. It had been confined to a tight range, around the ¥120 level, from August and that area also represents the region of the 200-day MA. During the September/October sell-off in global stock markets there was some safe haven buying of the Yen which acted as a headwind for the stock market but recent Dollar strength has acted as a tailwind and reaffirms the inverse correlation between the Yen and domestic stock market. 

Yet for now, Toyota is still highly reliant on gasoline- and diesel-powered cars. Last year, around 14% of Toyota’s global sales were hybrid vehicles, including plug-ins. Most of the remaining sales were vehicles powered by gasoline and some diesel, though a detailed breakdown wasn’t available.

Toyota has posted record profits in recent years, partly thanks to growing sales of profitable but gas-guzzling sport-utility vehicles and pickup trucks in the U.S., backed by lower fuel prices.

The vision to eliminate gasoline- and diesel-powered cars was a part of Toyota’s wider green car strategy unveiled Wednesday.

By 2020, Toyota aims to cut carbon-dioxide emissions from new vehicles by more than 22% compared with its 2010 global average. It ultimately hopes to take that to a 90% reduction by 2050, the auto maker said.

To do so, Toyota plans to sell roughly 7 million gas-electric hybrid vehicles world-wide over the next five years, it said. Toyota has sold around 8 million hybrids since it started selling them 18 years ago.

Toyota also plans to sell at least 30,000 fuel-cell vehicles a year world-wide by around 2020, it said.

 

The fallout from Volkswagen’s diesel emissions scandal means other manufacturers, that had not focused on a “clean diesel” marketing campaign, are capitalising on the story by promoting their own innovations.  Toyota has made some big bets on hybrid and fuel cell cars and the debacle of Volkswagen’s fraud enhances the potential that these decisions will succeed in enticing consumers to try a new solution over the medium term. 

Analysts in Tokyo said the sharp rise in Japanese markets reflected the low closing level on Tuesday and a large amount of short covering.

“The background is a rise in Chinese shares yesterday, which spread to Europe and the US, then back to Japan,” said Mr Motomura, who noted that Nikkei 225 futures had already rallied above 18,000 in Chicago before the Japanese market opened.

Tomohiro Okawa, Japan equities strategist at UBS in Tokyo, said the market had been behaving strangely since the previous day. “I don’t think there’s a big change in trend,” he said.

The Shanghai Composite closed 2.3 per cent higher, while the tech-heavy Shenzhen Composite added 3.3 per cent. Hong Kong’s Hang Seng rose 4.1 per cent for its biggest one-day gain since December 1 2011.

Elsewhere around the region, Australia’s S&P/ASX 200 added 2.1 per cent for its third-best day of the year, Korea’s Kospi gained 3 per cent for its best day since December 21 2011 and Taiwan’s Taiex jumped 3.6 per cent for its second-best day of 2015.

The Nikkei-225 lost momentum from June and pulled back sharply in August to complete a Type-2 top. Following a major reaction against the prevailing trend market participants cast around for reasons for why the drawdown was so abrupt. In this case the reasons did not have a great deal to do with Japanese equities but more with closing out of carry trades which saw the Yen strengthen which in turn hit stops. 

Nikkei-225 – The Index experienced a steep decline over the last week but found at least near-term support in the region of 18,000 but a sustained move back above 19,200 will be required to signal a return to demand dominance beyond current scope for a continued bounce. 

Bubbles always come in different forms 
With the big cliff of April 2017 in sight, enjoy the last party like a driver careening to the cliff's brink. Japan is now painted in a completely optimistic light, with the pessimism which permeated Japan after the Great East Japan Earthquake in 2011 forgotten and expectations for the 2020 Tokyo Olympics riding high. The bank lending balance to the real estate sector is at a record high, and we expect bubble-like conditions in the real estate market to heighten due to increased investment in real estate to save on inheritance taxes. History repeats itself, but always in a slightly different form. We have no choice but to dance while the dance music continues to play. 

Japan heading towards its fourth bubble 
Japan has seen three bubble-like rises in real estate prices; in the early 1970s, the late 1980s, and the mid 2000s. We are now jumping into a fourth bubble. The three preconditions needed for a real estate bubble are: 1) a plausible scenario that supports the bubble, 2) more aggressive bank lending to the real estate sector, and 3) tax reforms that boost real estate prices. We believe that current conditions neatly meet these requirements: 1) a plausible scenario – although we see no reason to believe that everything will be fine until the Tokyo Olympics, it sounds plausible on the surface; 2) record-high bank lending to the real estate sector; and 3) widespread real estate investment to save on inheritance taxes which were raised.  

We currently have no choice but to continue dancing
The Japan Revitalization Strategy, announced as the government's new growth strategy, includes many policies which push Abenomics' bedrock philosophy of survival of the fittest, and thus Japan's globalization seems right around the corner. As a result the middle class will likely be greatly segmented, with the gap between the rich and poor widening. An increase in high-networth individuals will boost savings, which will keep interest rates declining. This will likely push up real estate prices as many investors seek higher yields. Moreover, Japan's promotion of English language education is also likely to increase Japanese real estate investment by overseas high-net-worth individuals. It is uncertain whether these strategies will prove successful. However, the party music is currently high and loud in Japan and we can only continue to dance – even though we know it would be the last dance.

A link to the full report is posted in the Subscriber's Area.

The long-term effects of quantitative easing will not be apparent for some time but we already have evidence that money printing inflates asset prices. There is every reason to expect that abundant credit, ultra-low interest rates and a government committed to reflation will support asset prices. 

Prime Minister Shinzo Abe’s efforts to stimulate the economy through monetary easing helped to spur bank lending while also lowering borrowing costs. Loans at city banks have risen for 2 1/2 years, according to the Bank of Japan. The average interest rate on new loans was 0.801 percent in
May, close to a record-low 0.767 percent last August, BOJ data show.

“While domestic lending grew in the first quarter, tighter loan spreads will constrain profit growth,” Yasuhiro Sato, chairman of the Japanese Bankers Association, said at a news briefing on July 16. He expects overseas lending to keep expanding and doesn’t see any change in the direction of interest margins yet.

Overseas Expansion
Sato is also chief executive officer of Mizuho, which said this year that it’s buying North American loans from Royal Bank of Scotland Group Plc for $3.5 billion. Sumitomo Mitsui last month agreed to purchase General Electric Co.’s European buyout- lending unit for about $2.2 billion. Mitsubishi UFJ’s main lending arm is considering acquiring a bank in Indonesia, the Philippines or India, Asia-Pacific CEO Go Watanabe said in an interview last month.

 

Quantitative easing is positive for the banking sector because it creates an incentive to borrow and invest not least among banks themselves. Despite the loss of purchasing power in the Yen, the availability of credit has allowed Japanese banks to invest in their overseas operations which flatter consolidated earnings. This is likely to continue considering the Bank of Japan’s commitment to persistent easing. 

Same-store sales in Japan dipped 12 percent in June as the cooler weather curbed demand for summer clothes, the company said earlier this month.

Net income surged 36 percent in the three months ended May to 27.6 billion yen, based on nine-month figures the company released Thursday in Tokyo. Sales gained 23 percent to 398.4 billion yen in the quarter.

Investors have bet billionaire Tadashi Yanai’s clothing retailer, which offers basic designs made with advanced materials at low prices, will grow by exporting its model to faster-growing markets like China and the U.S.

The shares trade at about 41 times projected earnings, compared with about 31 times for Inditex, which sells Zara casual clothes and is Uniqlo’s bigger global rival and 24 times for Hennes & Mauritz AB, which retails the H&M brand.

 

As the largest company in the price weighted Nikkei-225, Fast Retail exerts an influence on the direction of the overall market. As it expands internationally, the company will be consolidating more foreign earnings into a Yen which continues to weaken. 

National Australia Bank – down 20% since April and testing the lower side of a two-year range. If support is going to be found this is the area amid a short-term oversold condition.

 

Why is China’s lurch into deflation on the GDP deflator, but not the CPI measure, so important? We have pointed out before (unfortunately we don’t have space for the chart here) that in Japan during the 1990s the thing to watch to see the havoc that deflation was wreaking on nominal revenues and debt/income loads was not the CPI, but rather the GDP deflator, which fell far faster than the CPI. Economic agents produce far more than just consumer goods and services and the GDP deflator is a much wider basket of goods and services and includes exports and investment goods. Clearly the descent into outright GDP deflation in China explains the more aggressive, even slightly panicky, policy easing measures there.

We also pointed out last week that China’s move into BoP deficit imposes a substantial monetary headwind on the economy. China may wish to keep the renminbi stable at this time while the IMF is currently considering including it in the SDR currency basket. But the economy is simply not in a position to withstand a major yen decline bringing down the currencies of its competitors in the region (and the additional deflationary impulse). I remain convinced that China must start guiding its currency down against the dollar and it can do that easily now it has a BoP deficit by doing absolutely nothing (ie not intervening any longer to hold it up)! China will also take the IMF’s recent declaration that the renminbi is no longer undervalued as justification for these actions - link.

Worrisome deflation is already being imported into the US, especially from Japan (see chart below). China (blue line) has yet to participate, but a further round of Asian devaluations will inevitably see waves of deflation heading westwards – as in 1997/98. Watch this data closely.

A link to the full report is posted in the Subscriber;'s Area. 

The Yen has been a catalyst for competitive currency devaluation across the Asian region since the BoJ initiated its QE program in 2012. As the Yen extends its downtrend there is potential that it will act as an additional incentive for regional competitors to devalue their currencies.

The US Dollar broke out against the Yen last week and a sustained move below ¥122 would be required to begin to question medium-term scope for continued upside. 

Last week’s event was another enjoyable visit to Singapore and was an apt time to ruminate on Lee Kwan Yew’s legacy of turning a tropical backwater into a first world private banking and high end manufacturing centre. Delegates came in from Argentina, Australia, Japan and of course Singapore which led to some interesting and varied discussions.

Singapore’s stock market is being led higher by the banking sector and shares a high degree of commonality with Taiwan and South Korea. The Index is somewhat overbought in the short-term and some consolidation of recent gains in looking likely. However a sustained move below the 200-day MA, currently near 3400, would be required to question medium-term scope for additional upside.

As one might imagine the main topic of conversation was on the outlook for the Asian region not least following China’s explosive breakout over the preceding three weeks.  Delegates were also interested in the outlook for the European region and we also looked at the S&P 500. We looked at the oil price and a number of related instruments. We also looked at gold prices and a number of miners, select Singapore shares as well as a wide range of international bank shares. We also had a wide ranging discussion on currencies. 

Eisai Co.’s shares had their biggest gain on record after partner Biogen Idec Inc.’s experimental drug for Alzheimer’s slowed progression of the disease in an early-stage study.

The Japanese drugmaker’s shares climbed as much as 21 percent to 8,748 yen in Tokyo trading today, headed for the largest gain since Bloomberg started tracking the data in 1974.The benchmark Topix Index rose 0.5 percent.

Biogen’s drug BIIB037 reduced beta amyloid, a protein fragment, in the brains of Alzheimer’s patients. It also cut cognitive decline, with higher doses and longer treatment resulting in increased improvement in an early-stage trial of 166 patients announced on March 20.

Eisai has an option to co-develop and co-promote BIIB037 with Biogen. The two companies are likely to equally split profits if the drug is successful in the last-stage trial as part of their Alzheimer’s disease collaboration, Thomas Wei, an equities analyst at Jefferies Group LLC, said in a note to clients.

 

The ability of Japan’s numerous world class companies to deliver in an increasingly competitive global economy has been questioned over the last decades as economic malaise sapped investment in R&D and risk takers were excluded from board rooms. However, if Abenomics has succeeded in anything it is to cause some reassessment of Japan’s ability to reinvent itself. 

“The disappointing output figures indicate that the Bank of Japan’s view on growth is too optimistic,” Capital Economics said. “We still believe that the Bank will announce more easing at the late-April meeting.”

The BOJ last month raised its growth forecast for the fiscal year starting in April to 2.1 percent, with Governor Haruhiko Kuroda saying slumping oil prices will boost growth.

Kuroda also said the drop in oil could delay inflation reaching the BOJ’s 2 percent target next fiscal year, and some economists see a risk of prices falling briefly this summer.

While the Bank of Japan is projected by economists to boost stimulus later this year, some officials inside the central bank think further monetary easing to shore up inflation would be a counterproductive step for now, according to people familiar with the talks. They are concerned it could trigger declines in the yen that damage consumer confidence.

 

In the bad news is good news category, weak economic results increase the potential that additional stimulus measures will be enacted. The Yen has been unwinding an oversold condition relative to the 200-day MA since December but a sustained move below the 200-day MA would be required to question medium-term US Dollar dominance. 

LNG prices in Japan, the world’s biggest buyer of the fuel, will probably plunge 35 percent in 2015 and Indian costs will decline 33 percent, according to Energy Aspects Ltd., a London- based consultant. Costs in Asia will this year average below $10 per million British thermal units for the first time in four years as new projects in Australia and the U.S. boost supply through 2016, Bloomberg New Energy Finance said.

Most LNG in Asia is linked to crude costs with a time lag of several months, so Brent’s 49 percent drop in the second half of 2014 hasn’t fully filtered into prices. Global demand for the gas chilled to minus 170 degrees Celsius (minus 274 Fahrenheit) will rise 9.8 percent this year amid increased imports by India and southeast Asia, after climbing 0.5 percent in the first nine months of 2014, according to Sanford C. Bernstein.

“We are already seeing, at current prices, renewed interest from Indian buyers,” Laurent Vivier, vice president for strategy and market analysis at Total Gas & Power, said Monday by e-mail. “There is some flexibility in the demand as well. When prices fall to current levels, it creates additional demand.”

 

Consumers have bemoaned the link between natural gas pricing and crude oil over the last decade but the pendulum has swung back in their favour over the last six months. As major energy importers without significant domestic supply Japan and India are major beneficiaries of the decline in oil prices. 

For Japan, the fall in oil prices gives the BoJ additional room to stimulate the economy while consumers will see they have additional cash. The Nikkei-225 continues to firm within its three-month range and a sustained move below 16,500 would be required to question medium-term potential for a successful reassertion of the medium-term uptrend. 

Your comment regarding the reasoning behind DXJ's fall by 8% the day the NIKKEI was up 389 points is technically and politically "correct". 

Nevertheless it is a rip off for the average investor. Even knowing in advance that the fund was about to pay distributions one would expect a drawdown of about 1-2 % max. A figure of 8 % (on a rising market!) is an insult to investors.

I would really like to know whether legal grounds for prosecution of the issuer (WisdomTree) exist. In any case this is not a product to be recommended as an investor should be more concerned in getting the market direction right than checking whether he or she are going to be ripped off by the issuer ! The SEC will be contacted anyway.

 

Thank you for this email but the 8% decline was in response to an 8% dividend resulting from short-term and long-term cap gain payments of more than $4 between the 11th and 18th. DXJ’s reference instrument is a dividend weighted total return index and it has spent time over the last year trading at a discount. If a fund trades at a discount and orients towards high dividend payers, the potential for it to return capital in somewhat larger payments increases. 

The fund had omitted a payment in March and September so cash had obviously built up which was returned to holders on the 18th. This is not a bad deal for investors. However traders, particularly those participating on a leveraged basis may have been pressured by the short-term gyrations.  

Do you know why DXJ is down over 8% today when the Nikkei was up 389 points?

The Wisdomtree Japan Hedged Equity Fund (DXJ) paid short and long-term capital distributions today, which has affected the fund’s price but not the overall trend or ability to reflect the hedged performance of the Japanese market. 

Even after recent gains, the yen has slumped 4.9 percent in the past three months, the worst performer after Norway’s krone among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The dollar advanced 6.3 percent and the euro rose 1.9 percent.

The Bloomberg Dollar Spot Index fell for a third day before a report tomorrow forecast to show U.S. retail sales increased for a second month in November.

“Retail sales are really important tomorrow,” Steven Englander, head of Group of 10 currency strategy at Citigroup Inc. in New York, said by phone. “A good retail sales number would at least set investors up for putting on long-dollar positions at the beginning of next year.” A long position is a bet the dollar will increase in value. 

 

Shinzo Abe’s decision to call a snap election introduced an uncertainty which will be resolved on the 14th. Considering how swiftly the Yen had fallen in the last few months, the prospect of an unfavourable result, however unlikely, has been enough for traders to take profits in what has been an overextended decline. 
 

Hi David & Eoin, I wanted to get FTM thoughts and opinion on where the best investment returns could be had over the next 12 months and what would be the key things to watch for? Thanks for an excellent service 

Thank you for your kind words and your question. This is a topic we cover almost daily in the written commentary and the audio but it is a good time to summarise our views. 

Let’s ruminate for a moment though on the timing of your question. Generally speaking, the last six weeks of the year is given over to thinking about the possibility of a Santa Claus rally and people don’t generally look at the outlook for the next year until the last week of December or the first week of January. It made headlines during the week that Goldman Sachs had released its prognostication for the coming year, which may have prompted your email. However I believe it is worth considering that the stock market is a discounting mechanism and as a bull market progresses we tend to want to discount cash-flows from increasingly further into the future. It is a measure of how strong the market has been over the last month that investors are already planning for next year. Five consecutive weeks to the upside suggest some consolidation is increasingly likely.

Strategists are seeing more weakness in the yen on bets Prime Minister Shinzo Abe will do whatever it takes to haul the economy out of recession after government and Bank of Japan stimulus sent the currency down 14 percent since June.

“Once you start to push on the dam, there’s enough pressure and it starts to break, you can create these explosive moves in terms of the water cascading lower,” Sebastien Galy, a senior currency strategist at SocGen in New York, said yesterday by phone. “It can get uncontrolled and some of the moves that we’ve seen in the yen don’t seem to be normal moves in the sense that they’re very aggressive.”

Abe’s call this week for a snap election fed into the growing bearish sentiment for the yen, as did his decision to delay a sales tax increase needed to rein in the world’s biggest debt burden. The yen already tumbled 27 percent since he took office in December 2012, fueled by government largess, a determination to help exporters, and central bank bond-buying that’s driven inflation above sovereign yields.

 

The sales tax hike that has just been delayed was originally designed to bolster government finances amid a concerted attempt to initiate asset price inflation. Postponing it a short-term tailwind for the economy, but removes an argument for Yen strength by putting Japan’s high debt to GDP ratio back on the radar of international traders. 

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Japan’s $1.2 trillion Government Pension Investment Fund will increase its allocation target for local shares to about 25 percent from 12 percent, the Nikkei newspaper reported without attribution. GPIF will also boost its holdings of foreign bonds and stocks to about a combined 30 percent from 23 percent, while reducing domestic debt to the 40 percent level from 60 percent, the Nikkei said Oct. 18

“Twenty-five percent is more than the market expected,” said Kenji Shiomura, a Tokyo-based senior strategist at Daiwa Securities Group Inc., Japan’s second-largest brokerage. “They probably can’t buy all the Japanese stocks they need to get to 25 percent by the time they announce it. However, it wouldn’t be a surprise if they’ve already started moving bit-by-bit.” 

 

The Dollar unwound much of its short-term overbought condition from early this month and found support last week in the region of the January highs. Some additional steadying in this area is a possibility but a sustained move below the 200-day MA, currently near ¥105 would be required to question medium-term Dollar dominance. 

 

The yen fell the most in a week and domestic stocks unwound some of their slide after Shiozaki, whose ministry overseas the nation’s $1.2 trillion Government Pension Investment Fund, said today the government will conduct some reforms within the existing law and there is no intention of postponing the process. The GPIF changes are accompanying Abenomics, a three- pronged policy of radical monetary easing, fiscal stimulus, and pro-growth policies.

The currency strengthened 0.3 percent yesterday, the most since Sept. 3, after a Yomiuri newspaper report cited Shiozaki as saying that he is in no hurry to submit a bill needed to review GPIF’s allocations.

“The yen’s reaction after Shiozaki’s remarks explains how closely the market is listening to him,” said Daisaku Ueno, the Tokyo-based chief currency strategist at Mitsubishi UFJ Morgan Stanley Securities Co. “It helps explain the enormous expectations there are around how the minister in charge of the world’s largest pension fund will revamp GPIF in a way that cater to Abenomics’ fight to exit deflation. Shiozaki is ‘Mr. Risk-on’.”

 

The three arrows of Prime Minister Abe’s program for Japanese economic revival are fiscal stimulus, monetary easing and structural reform. Of these the monetary stimulus has been both the easiest to achieve and the highest profile. The Yen has been among the weakest currencies in the world over the last two years and extended its decline this month to reassert the medium-term downtrend. 

With asset purchase tapering close to completion and the turning point in the Fed’s monetary policy cycle approaching, focus on the Fed’s monetary policy normalisation process is growing. On this front, the FOMC released a supplementary document that outlined its “policy normalisation principles and plans”.

The FOMC stipulated that the recent discussion on the topic of normalisation is part of its “prudent planning” and did not imply it “will necessarily begin soon”. According to the FOMC, many of the normalisation principles adopted in mid-2011 remain applicable. However, in light of changes to the System Open Market Account (SOMC) portfolio in recent years and other enhancements in the tools available to the FOMC, some adjustment to the previous guide may be necessary.

All but one member of the FOMC agreed on the following key elements of the approach intended to be taken when monetary policy normalisation was deemed appropriate:

(a) When less policy accommodation is warranted, the FOMC will raise the “target range” for the funds rate. During normalisation, the Fed intends to move the funds rate into the target range “primarily by adjusting the interest rate it pays on excess reserve balances” (IOER).

(b) The Fed also intends to use an overnight reverse repurchase agreement facility and other supplementary tools to help control the federal funds rate. In our view, this is designed to keep the effective fed funds rate from falling too far below the IOER rate.

(c) The size of the Fed’s balance sheet will be reduced in a “gradual and predictable” manner, primarily by ceasing to reinvest repayments of principal on securities. The FOMC expects to “cease or commence phasing out reinvestments” after it beings to raise the target range for the federal funds rate. Selling of Mortgage Back-Securities is not anticipated to be part of the normalisation process. But should limited sales be warranted in the longer run, such sales would be communicated in advance. 

A link to the full report is posted in the Subscriber's Area.

As we approach the end of QE tapering, it is logical to ask when the size of the Fed’s balance sheet is likely to contract. Since the rally on Wall Street has been fuelled in large part by liquidity, the answer is an important one.