Great Chart: Oil Prices vs. Japan Trade Balance

The recovery in oil prices since February 2016 has eased financial conditions for most of the Middle East countries and has reversed the path of the corporate default rate for US energy companies exposed to the shale industry. Higher oil prices have also brought back inflation in most of the economies, hence pushed up expectations of nominal growth rates. However, for countries that are heavy importers of energy (i.e. Japan), higher oil prices usually mean a deterioration of the Trade Balance. Japan has limited domestic proved oil reserves (44 million barrels), which means that the country is a net importer of oil. According to the EIA, Japan is the fourth-largest petroleum consumer and the third largest net importer, and its daily consumption in 2016 was of 4 million barrels per day. Therefore, if we plot the WTI futures prices (6M lead) with the Japanese trade balance, we can notice a significant co-movement between the two times series. This chart suggests that oil prices can be used as a sort of leading indicator for the Japanese trade balance. For instance, when oil prices entered a bear market in 2014, the trade balance switched from a 1.1tr JPY deficit in the middle of 2014 to a 350bn JPY surplus in H2 2016. Hence, with oil prices constantly trending higher with the front-month contract on the WTI trading at $70 per barrel, its highest level since Q4 2014, we can potentially anticipate that the Japanese trade balance will go back into deficit in the medium term.

What are the consequence for the Japanese Yen?

In our BEER FX model, we saw that exchange rates (in log terms) react positively to a positive change in interest rate differential and in terms of trade differential, and negatively to a change in inflation rate differential. Hence, if we expect import prices to rise in Japan due to higher energy costs (especially Oil), the terms of trade should ‘deteriorate’ and therefore have a negative impact on the currency. However, we know that the Japanese Yen is also very sensitive to the current macro environment and often acts as a safe-have asset when the risk-off sentiment rises (Yen appreciates in periods of equity sell-off). In our view, the problem Japanese officials may face in the following 6 months is higher energy prices combined with a strong Yen at 105 (vis-à-vis the US Dollar), which will directly weigh on the country’s economic outlook as fundamentals will start to deteriorate, leaving less and less room for some BoJ manoeuvre.

Chart: Oil prices (WTI, 6M Lead) vs. Japan Trade Balance (Source: Eikon Reuters)

Japan Trade

Great Chart: Term Spread Differentials (US, Germany and Japan)

In this article, we define the term spread of a specific country by the difference between the long-term (10Y) and the short-term (2Y) sovereign yield, which is also referred as the yield curve. As we mentioned it in one of our previous Great Chart articles (here), empirical research has shown a significant relationship between the real economic activity of a country and the yield curve. In today’s edition, we chose to look at the historical developments of the term spread differentials, between the US and Germany and the US and Japan.

Over time, we notice that the term spread has some interesting co-movement with the exchange rate. For instance, between 2005 and 2017, a widening term spread differential between the US and Germany was favourable to the USD/EUR exchange rate (here), meaning that the Euro was appreciating when the US yield curve was steepening more significantly than the German one. However, we saw that the relationship between the two times series broke down in early 2017 and has actually reversed over the past 14 months (here). In other words, based on the current market levels, the 2Y10Y term premium in Germany offers 56bps more than the US. Hence, as the term structure in the US has flattened strongly relative to Germany (yield curve steepened from 50bps in July 2016 to 118bps), the US Dollar depreciated.

This chart shows the evolution of the term spread differentials – between US and Germany and between US and Japan – since 1985. We can observe a strong correlation between the two times series over the past 30 years, with the term spread differential against Germany trading at -57bps, its lowest level since June 2006, and at 42bps against Japan, its lowest level since June 2008, respectively. An interesting observation comes out when we look at the spread between the two TS differentials (US-Japan vs. US-DE), which simply comes back at looking at the cross term spread differential between Germany and Japan. At the exception of the year 1992, the DE-Japan TS differential has always traded between -1% and +1%, and is currently standing at the high of its long-term range. The TS differential currently trades at +1% on the back of a steepening German yield curve since the summer of 2016 (2Y10Y moved from 52bps in July 2016 to 119bps today). It it a good time to play the convergence between the two term structure, i.e going long the German 2Y10Y term spread and short Japan 2Y10Y? The risk of the trade is on Japan side, as shorting the 2Y10Y would imply a steepening yield curve with either the 2Y yield going down or the 10Y rising. With the current BoJ ‘yield curve control’ (YCC) policy, we know that a steepening yield curve in Japan is difficult for the time being, but it will be interesting to see where TS differentials stand in a couple of months.

Chart: Term spread Differentials – Japan and Germany vs. US (Source: Reuters Eikon)

Term Spreads ALl

Great Chart: TOPIX vs. USDJPY

As we always like to look at the Japanese Yen charts (USDJPY, AUDJPY, MXNJPY) as a sort of alternative barometer of investors sentiment and overall financial conditions, we chose an interesting chart this week that shows a scatter plot of the Japanese equity market (TOPIX) with USDJPY. The two assets have shown a significant relationship over the years, especially since Abe took office in Q4 2012 and the BoJ introduced QQME (i.e. extremely accommodative monetary policy) on April 3rd 2013. Investor Kyle Bass was one of the first to introduce the term Pavlovian response to this ‘weaker yen, higher equities’ relationship in Japan, which brought a lot of ‘macro tourists’ instead of long-term investors.

However, we noticed that the relationship between the Yen and the TOPIX broke down in Q2 2017. While the Japanese equity market has continued to soar over the past few months, currently flirting with the 1,900 psychological level (its highest level since 1991), USDJPY has been less trendy and has been ranging between 107 and 114 (see divergence here). Hence, we decided to plot a scatter chart between the two assets using a weekly frequency since 2001.

As you can see, a strong Japanese Yen (i.e. USDJPY below 100) usually goes in pair with a weak equity market. For instance, we barely see the TOPIX index above 1,000 when the USDJPY trades below the psychological 100 level. However, as the exchange rate increases, we see more dispersion around the upward sloping linear trend; for a spot rate of 120, we had times when the TOPIX was trading at 800 and other times when it was trading at 1,800. We did a simple exercise and regress the exchange rate returns on the equity returns (both log terms) to see if we get some significant results, using the following equation:

As you can see, the coefficient Beta is economically and statistically significant at a 1-percent level. Using 16 years of data, we find that a 1-percent increase in USDJPY spot rate is associated with a 0.76% increase in the stock market.

We highlighted the point where we currently are in the chart (Today), which is a TOPIX at 1,889, its highest level in the sample, for a USDJPY spot rate of 112.80. We can notice that the point is located at an extreme level of dispersion, and the question we raised a few weeks ago was ‘Can the divergence between the equity index and the exchange rate continue for a while?’

We think that the stock market in Japan will struggle to reach new highs and generate some potential interesting returns in the months to come due to the poor performance of the banking system (strong weigh in the index) and the constant decrease in the effectiveness of the BoJ policy measures. We mentioned a month ago that the Japanese Yen was 26% ‘undervalued’ relative to its 23Y average value of 99.3 according to the Real Effective Exchange Rate (REER valuation) (see here), hence we find it difficult to imagine a super bear JPY / Bull TOPIX scenario. In addition, we also raised the fact that the current level of oil prices were going to deteriorate Japan Trade Balance in the future (see here), pushing back the current account in the negative territory and potentially impacting the stock market.

Chart: Scatter plot of TOPIX vs. USDJPY – weekly frequency (Source: Reuters Eikon) 

Great Chart: US 2Y10Y yield curve vs. USDJPY

Among all the potential compatible candidates that show an interesting correlation vis-à-vis the USDJPY (i.e. 10-year US-Japan interest rate differential, Topix index …), I chose this week to overlay the currency pair with the US 2Y10Y yield curve. If we look at the past three years of data, we can notice an interesting development that has started since mid-April of this year. While the US yield curve and USDJY has shown strong co movement between January 2015 and April 2017, it has been a different story over the past 8 months.

In the US, the yield curve has constantly been falling and is currently trading at 51.5bps half the value where it was sitting in April 2017. On the other hand, the Japanese Yen has been oscillating within a 7-figure against the green back, between 107.50 and 114.50. What is interesting about this divergence is that it started more or less at the same time of the Topix vs. USDJPY divergence, with Japanese equities soaring from 1,500 to 1,800 and a Yen mean reverting around 111 against the USD ( see tweet Topix vs. USDJPY).

The question now is: How long can this divergence persist in the near to medium term? The current level of the US yield curve has raised the concern of many market participants as in theory it is viewed as a strong predictor of future recessions. Looking at economic and financial data, I don’t personally believe that we are very close to a potential recession in the US; in addition, the yield curve is still far from its extreme lows of -20bps and -95bps we saw in November 2006 and May 2000 (if we just look at the past 30 years of data). However, I think that we may see some US Dollar weakness against the Japanese Yen, on a back of slowly disappointing fundamentals (easing all the excitement on the expected Fed rate hikes) and geopolitical uncertainty. Moreover, the Japanese Yen is 26% ‘undervalued’ relative to its 23Y average of 99.3 according to the real effective exchange rate ( see JPY REER).

Chart: USDJPY (Candlesticks, rhs) vs. US 2Y10Y yield curve (Source: Bloomberg)

JPY US Curve

BIS Nominal and Real Effective Exchange Rates (EER): NEER and REER

Abstract: In this article, we introduce the two effective (i.e. multilateral) exchange rates that measure the value of a specific currency in relation to an average group of major currencies: the Nominal Effective Exchange Rates (NEER) and the Real Effective Exchange Rates (REER). Both are calculated by comparing the relative trade balance of a country’s currency against each country within the index, but the REER is adjusted by the ratio of domestic price to foreign prices.

Using the BIS time-varying weights, we also look and comment the development of the CNY NEER and JPY REER over the past twenty years.

LINK ===> NEER and REER

DATA FILE ===> NEER_REER

Japan: Flirting with Helicopter Money

As we already mentioned in a few articles, the Yen strength over the past year was going to be a problem somehow for PM Abe and the BoJ. After reaching a high of 125.86 in the beginning of June last year, USDJPY has entered into a bearish trend since last summer [2015] with the Yen constantly appreciating on the back of disappointments coming from the BoJ (i.e. no more QE expansion). The pair reached a low of 99 post-Brexit, down by 21.3% from peak to trough, sending the equities down below 15,000 (a 30% drawdown from June high of 21,000). The plunge in the stock market was directly reflected in the performance of the Japanese pension and mutual funds; for instance, the USD 1.4 trillion GPIF lost more than USD 50bn for the 12 months through March 2016 (end of the fiscal year). The Fund, as the graph shows below (Source: GPIF) , has been selling its JGBs to the BoJ over the past few years due to Abenomics (the allocation declined from 67.4% in 2011 to 37.8% in 2015) and has mainly been increasing its allocation in domestic and international stocks. With more than USD 13 trillion of sovereign bonds trading at a negative yield – the Japan Yield Curve negative up to 15 years – you clearly understand why we am always saying that Abe and the BoJ cannot lose against the equity market.

A the situation was getting even worse post-Brexit, with the Yen about to retest its key 100-level against the US Dollar, the Yen weakness halted suddenly on rumours of potential ‘Helicopter Money’ on the agenda.

It started when Reuters reported that former Fed chairman Bernanke was going to meet PM Abe and BoJ Kuroda in Tokyo to discuss Brexit and BoJ’s current negative interest rate policy. However, market participants started to price in a new move from the BoJ – i.e. Helicopter Money, a term coined by American economist Milton Friedman in 1969. In his paper ‘The Optimum Quantity of Money’, he wrote:

‘Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.’

In short, Helicopter Money is a way of stimulate the economy and generate some inflation by directly transferring money to the nation’s citizens. This money, as a contrary of refinancing operations or QE, will never be reimbursed.

Buy the rumors, sell the fact?

The effect on the currency was immediate, and USDJPY soared from 100 to [almost] 107 in the past 12 years, levitating equities as you can see it on the chart below (SP500 in yellow line overlaid with USDJPY candlesticks). It was confirmed that on the week ending July 15th, the Yen had his biggest drop in the 21st century. The SP500 index reached its all-time high of 2,175 today and in our opinion, the Yen weakness is the best explanation to equities testing new highs in the US.

(Source: Bloomberg)

Talking with Bernanke: Conversations and Rumors

As the meeting was held in private, we don’t have any detail on the conversation. On common sense, you would first think that the discussion would be on the potential BoJ retreat from the market as its figures are starting to be really concerning (35% of JGBs ownership, 55% of the country’s ETF, 85% total-assets-to-GDP ratio). It is clear that the BoJ cannot continue the 80-trillion-yen program forever, and from what we see in Japan [markets or fundamentals], the effectiveness of monetary policy is gone.

However, it looks to me that market participants are convinced that the BoJ will act further, which is to say adopt a new measure. This was clearly reflected in the currency move we saw, and they [better] come with something in the near future if Japan officials don’t want to see a Yen at 95 against the greenback. The next monetary policy meeting is on July 29th, an event to watch.

Introducing Helicopter Money

We run into a series of really nice and interesting articles over the past couple of weeks, and we will first start by introducing this chart from Jefferies that summarizes the different schemes of Helicopter Money very well.

chopper money schematic

We were only aware of the first scheme, where the central bank directly sends money to the households or directly underwrites JGBs. However, as Goldman noted, the second popular scheme would be to convert all the JGBs purchased by the BoJ on the secondary market into zero-coupon perpetual bonds. When you think that a quarter of Japan revenues from tax (and stamps) are used to service debt with the BoJ running out of inventories (i.e. JGBs) to buy, the second scheme makes a lot of sense in fact.

The other part that Goldman covered was on the legal and historical side. As the picture below (Source: Jefferies) shows you, Article 5 of Japan’s Public Finance Law ‘prohibits the BoJ from underwriting any public bonds’. However, under special circumstances, the BoJ may act so within limits approved by a Diet resolution. In other words, the BoJ can underwrite public bonds. The only problem is once Helicopter Money is adopted, it is difficult to stop it. Japan already ‘experienced helicopter money’ in the 1930s after it abandoned the gold standard on December 13th 1931. It first devalued the Yen by 40% in 1932 and 1933, and then engaged in large government deficit spending to stimulate its economy; it was called the Takahashi fiscal expansion (Japan FinMin, Takahashi Korekiyo, also referred as the Japanese ‘Keynes’). As Mark Metzler described in Lever of Empire: The International Gold Standard and the Crisis of Liberalism in Prewar Japan (2006), ‘increased government spending was funded by direct creation of money by the BoJ’.

helicopter primer 2

It was not until 1935 that inflation start rising, and the expansionary policies of Takahashi’s successor after the FinMin assassination in 1936 led the country to a balance of payments crisis and hyper-inflation.

‘Be careful what you wish for’.

In our opinion, as central banks shouldn’t be too focus on the currency, an interesting way of stimulating an economy would be by transferring money directly to citizens’ account. The BoJ could put a maturity date to the money they transfer (i.e. the citizen has one year maximum to spend the money he received), and ‘obliged’ their citizens to spend it on Japanese goods, therefore stimulating the internal demand and eventually leading to a positive feedback loop.

The announcement of additional measures from Japan in the near future should continue to weigh on the Yen, and USDJPY could easily re-reach 110 quite quickly if rumors become more and more real.

Thoughts on Brexit and European Banks

Brexit and Cable 

We remember that two years ago, the same night of the kick-start of the World Cup in Brazil on June 12th 2014 (Brazil won 3-1 against Croatia), Mark Carney gave a speech at the Mansion House giving an update on the BoE’s monetary policy. At that time, he hinted that interest rates may rise sooner than had been expected; and the market was starting to price in a 25bps hike by the end of Q4 2014. Cable was trading at a (almost) 6-year high ($1.72) in a year when the British economy grew at its fastest pace for nine years at 2.8% (and the fastest-growing major economy in 2014 as you can see below).

(Source: Telegraph)

Two years later, the Official Bank rate is still at 0.5%, Cable is down 24% trading at around 1.33 after hitting a low of 1.2798 last week and the market has been positioned for a rate cut since Brexit in order to re-establish confidence in the UK market. While the BoE disappointed today by keeping the benchmark rate steady at 0.5% (only Gertjan Vlieghe voted for a 25bps cut) and no further easing, markets are pricing in a 80%+ chance of a rate-cut later this year with the September and December Short Sterling futures contract trading at 99.63 and 99.67 respectively (meaning that the implied rates are 37bps and 33bps).

Economists have slashed UK outlook and market participants are now expecting the UK economy to enter into a recession by the end of the year, mainly coming from a contraction in business investment and a sharp decrease in property prices. Major UK property funds (Aviva, M&G, Starndard Life, Aberdeen…) have suspended redemptions blaming uncertainty in the property market following Brexit. Therefore, a Summer Stimulus coming from the BoE could partially solve the UK current problematic situation.

The combination of an expected loose monetary policy in addition to poor fundamentals will continue to add pressure on the British pound in the coming months, and Cable could retest new lows toward 1.25.

A contagion in the European Banking system

We mentioned several times that a European Banking Crisis was one of the major Black Swans that could shake the market for a long period of time mainly due to a rise in the Non-Performing Loans (NPLs). For instance, in Italy, it was reported that 17% of banks’ loans are sour, a total of 360bn Euros of NPLs. To give you an idea, it was ‘only’ 5% in the US during 2008-2009. In consequence, Italian banks have been under attack (once again) with Monte Paschi now trading at 34 cents a share; the oldest surviving bank in the world (and Italian third largest lender) once traded at 93 Euros in May 2007, meaning that its market capitalization plummeted 99.6% in less than a decade. The five-year subordinated CDS is now trading at 1,506bps and the September 2020 subordinated bonds are now trading at 75 cents on the dollar. In response, the European Commission authorized Italy to use 150bn Euros of government guarantees to prevent a potential bank ‘run’ on deposits.

Even though the market has become less sensitive to ‘bad’ news coming from either Greece or Portugal, we strongly believe that Italy (or Spain) is one of the ‘scary’ countries to watch. If NPLs continue to rise in those countries, it will push Europe into a great depression and the write downs are going to be painful for all the stakeholders (equity holders, bond holders and depositors).

Another bank that investors have been following for a while now is Deutsche Bank. There is a funny chart (see below) that has been making the headlines which shows the bank’s share price over the past 18 months overlaid with Lehman’s share price before the collapse. The share hit an all-time low at 11.20 last week and lost 90% of its market cap since June 2007 high. Another scary figure is DB’s derivatives exposure of more than 70 trillion dollars, roughly equivalent to the world’s GDP.

DBandLehman

(Source: ZeroHedge)

 We think that European Banking Crisis is a topic that will stay on the table over the next few months, increasing the volatility in global equities and decreasing the effectiveness of the loose monetary policy run by the major central banks (i.e. ECB or BoJ). The Yen tends to appreciate in periods of massive sell off, hurting the main BoJ’s target (cheaper Yen for higher equities).

There are a lot of interesting topics to be discussed at the moment, and our next article will focus on Japan and the introduction of the Helicopter money.

 

 

Only BoJ matters…

Back in September 2014, we wrote an article It is all about CBs where we showed different central banks’ balance sheet as a share of the country’s GDP, which we thought could help explain exchange rates better than some macro models.

As you can see it on the chart below, the Bank of Japan’s balance sheet has been expanding drastically over the past three years and now held a total of 410tr Yen in assets. For an economy of roughly 500tr Yen, the ratio BoJ’s asset – to – GDP stands now at 82% (vs 20 to 30% for central banks).

Chart 1. BoJ Assets (Source: Japan Macro Advisors)

BoJAssets

When you think about it, the BoJ currently holds:

  • 35% of the JGBs (a ratio that is expected to grow to 50% by the end of 2017 – see chart 2).
  • 55% of the country’s ETFs (Chart 3). The BoJ is currently purchasing 3.3tr Yen of ETFs on an annual basis; if it accelerates its program to an annual rate of 7tr Yen, the central bank could become the first shareholder in about 40 of the Nikkei 225’s companies by the end of 2017 according to Bloomberg’s calculations.

Chart 2. BoJ’s JGBs holdings (Source: Japan Macro Advisors)

JGBsHolding

Chart 3. BoJ ETFs holdings (Source: Bloomberg)

ETFsJapan

On January 29th, Kuroda announced that the central bank will adopted negative interest rate policy in order to revive growth (and inflation) in the world’s third-largest economy. Like in the Eurozone (and many countries in the world), the BoJ has been charging a fee to excess reserves that financial institutional place at the central bank over the past three months now. However it doesn’t seem that the results are effective: Japan CPI switched to negative territory in March (-0.1% YoY) and is on the verge on entering into a quintuple recession since the GFC (see chart 4).

Chart 4. Japan’s GDP growth rate (Source: Trading economics)

JapanGDP

It looks like the market was expecting another ‘move’ from the BoJ overnight, and was disappointed by the status quo. The Nikkei index dropped 1000 points to close at 16,666 and sits now on its 50-day SMA, while USDJPY (white line) crashed almost 4 figures to 108, bringing down SP500 futures (blue line) with him to 2075. Therefore, these moves can conclude that for Japan, today, ‘only’ the BoJ matters in terms of news and the best you can do to ‘invest’ is to frontrun what Kuroda is doing.

Chart 5. USDJPY and SP500 futures (Source: Bloomberg)

USDJPYSP500

Some analysts or traders see a buy on dips opportunity at the moment (at around 108), however we would wait ‘til the US opens to decide such a trade. The VIX index (see chart below) has been trending upward over the past few days, which means we could see a couple of volatile days and a fly-to-quality to safe havens such as the Yen (or the Euro as well).

Chart 6. VIX index (Source: Bloomberg)

VIXindex

Macro 1: Japan and Abenomics

We kick these series of macro updates by an analysis on Japan’s current situation. As you can see it on the chart below, the Nikkei index plummeted 14.50% since December’s high, hitting a low of 16,017 last week (20% drawdown from peak to trough). If we look at the chart below, it seems we entered a bear market in Japan and market participants could still consider the recent spike as quick oversold recovery.

Nikkei

(Source: Bloomberg)

The Yen also reacted to this market headwinds and USDJPY was pushed down to 116 last Wednesday (its August support). One thing that surprises me and captivates me at the same time is the correlation’s strength between all asset classes. For instance, if we look at the chart below shows the moves of Oil (WTI Feb16 contract in yellow) and the SP500 Index (Green line). The amount of pressure that the commodity decline has caused to the overall market is excessive and has put a lot of nations in trouble.

Yen and Rest.jpg

(Source: Bloomberg)

If we have a look at fundamentals, Japan seems to be in a liquidity trap. The BoJ’s balance sheet total asset has surged by 143% [to JPY386tr] since December 2012 and the central bank is currently purchasing 80tr Yen of JGBs every month. It’s has been almost three years that Japan is engaged into a massive stimulus programme, which hasn’t had the expected effect. GDP grew modestly by 0.3% QoQ in the third quarter (avoiding a quintuple-dip recession after a first estimate of -0.2%) and the core inflation rate increased 0.10% YoY in November of 2015, ending a 3-month deflation period but still far from the 2-percent target set by Abe and Kuroda. It is hard to believe that after all the effort (mostly money printing), the situation hasn’t changed much. The question is ‘what would happen if the equity market falls to lower levels and the Yen appreciated further?’ What are Japan’s options?

GDP.png

Inflation

(Source: Trading economics)

We remember one article we read last October from Alhambra Investment Partners, which was talking about the Japanese QE. The chart below reviews all the QEs implemented since the GFC and how the BoJ reacted each time it had a difficult macro situation (i.e. low inflation, stagnating equities, zero-growth…). As you can see, Japan has constantly increase its QE size little by little until Abe was elected In December 2012 and went all-in by starting its QQME stimulus on April 3rd 2013. As Ray Dalio said in many interviews (when he talks about the Fed), the effect of QE diminishes if credit spreads are already close to zero (and asset prices already ‘inflated’), therefore additional measures will constantly be less effective than in the past (‘central banks have the power to tighten, but very little power to ease’). We believe this is exactly where Japan stands at the moment, giving Abe (and Kuroda and Aso) a harsh time.

QEJapan.PNG

(Source: Alhambra Investment Partners)

Another BoJ’s important indicator is the Japanese workers’ real wages, which went back into the negative territory, declining 0.4% YoY in November and marking the first fall since June 2015 according to the Ministry of Finance. Despite PM Abe’s hard work pushing companies to increase wages in order to fuel household consumption, household spending dropped by 2.9% in November and has been contracting most of the months over the past 2 years.

HouseholdSpending.PNG

(Source: Trading economics)

With a debt-to-GDP ratio sitting at 230%, one chart we liked that was published in a Bloomberg post showed the ‘growing dominance’ of the BoJ. The central bank held 30.3% of the country’s sovereign debt (as of September 2015), more than any investor class. For instance, the chart below shows the evolution of the holdings of both the BoJ and Financial Institutions (ex. Insurers); at  the start of the QQME, BoJ holdings were 13.2% vs. 42.4% for Financial Institutions. How long can this story continue?

Holdings.PNG

(Source: Bloomberg)

 

Japan update: Abenomics 2.0

As a sort of casual week end ‘routine’, I was watching the cross assets chart of the main economies that I usually follow. There are so many things that are happening at the moment, however a little update on Japan is always refreshing and useful.

The chart below shows the evolution of the equity market (Nikkei 225 index, Candles) overlaid with USDJPY (green line). As you can see, since Abe came into power in December 2012, there has been a sort of Pavlovian response to the massive monetary stimulus: currency depreciation has led to higher equities. However, the Nikkei 225 index closed at 17,725 on Friday and is down almost 15% from a high of 21,000 reached on August 11, whereas the currency has stabilized at around 120 and has been trading sideways over the past month with an 1-month ATM implied volatility down from 13.2 to 10.6% over the same period. If we look at the 20-day correlation (that I like to watch quite a bit) between the two asset classes, we are down from a high of 89% reached on August 24th to 38.1% in the last observation with an equity market being much more volatile.

EquityandYenC

(Source: Bloomberg)

In article I wrote back in September 2014 entitled The JPY and some overnight developments, I commented a bit on how Japanese Pension Funds (GPIF in my example) were decreasing their bonds allocation and switching to equities. And the questions I ask myself all the time is ‘Can the BoJ (and the other major CBs) lose against the equity market today?’ Indeed, the GPIF, which manages about $1.15 in assets, suffered a 9.4tr Yen loss between July and September according to Nomura Securities.

Abenomics 1.0 update…

We saw lately that Japan printed a negative GDP of 0.3% QoQ in the second quarter of 2015 and is potentially heading for a Quintuple-Dip recession in 7 years. In addition, the economy returned to deflation (for the first time since 2013) if we look at the CPI Nationwide Ex Fresh Food (-0.1% YoY in August, down from 3.4% in May 2014). We know that deflation and recession were both factors that Abe has been trying to fight and avoid, and the question is now ‘What is the next move?’

In a press conference on September 24th, PM Abe announced a sort-of new ‘arrow’ where the plan is to achieve a GDP target of 600 trillion Yen in the coming years (no specific time horizon mentioned as far as I know), which is 20% more from where the economy stands at the moment (JPY 500tr). In addition, he also target to increase the birth rate to 1.8 children per woman from the current low rate of 1.4 in order to make sure that the Japanese population don’t fall below 100 million in 50 years (from approximately 126 million today).

Clearly, this new announcement shows that the three-arrow plan has failed for the moment, and the BoJ only has been the major player in order to inflate prices over the past few years. I am wondering how this new plan is going to work in the middle of the recent EM economic turmoil. My view goes for additional stimulus, another 10 trillion Yen on the table which will bring the QQME program to a total of 90 trillion Yen. If you think about it, the BoJ is currently running a QE program almost as much as big as the Fed’s one in 2013 (85bn USD a month, 1 trillion USD per year) for an economy three times smaller than the US. Deceptions coming from Kuroda (i.e. no additional printing) could strengthen the Yen a little bit, but this will be seen as a new buying opportunities for traders or investors looking at the 135 medium-term retracement (against the US Dollar).

Here are a few figures and ratios to keep in my mind in the medium-term future…

Bank of Japan Total Assets

According to Bloomberg’s BJACTOTL Index, the BoJ’s balance sheet total assets increased by 210tr Yen since December 2012 and now stands at 368tr Yen. With an economy estimated at roughly 500tr Yen, the BoJ-total-assets-to-GDP ratio stands now at 73.6%.

JAPANassetC

(Source: Bloomberg)

Japan Banks total Assets

As of Q1 2015, the Japanese Banks reported a 1,818 trillion Yen exposure, which represents 363% as a share of the country’s GDP.

BanksJapanC

(Source: Bloomberg)

Based on the figures, you clearly understand that Japan’s government has been trying to push savers into stocks so Mrs Watanabe can take part of this artificial asset price inflation. However, a recent study from the Bank of Japan showed that Japanese households still had 52% of their assets in cash and bank deposits as of March 2015 (vs 13% for the American for instance).

The 15-percent recent drawdown in the equity market clearly shows sign of persistent ‘macro tourists’ investors, who are giving Abe and the BoJ board a hard time.

To conclude, the situation is still complicated in Japan, which is hard to believe based on the figures I just showed you. I strongly believe that Abe cannot fail in his plan, therefore if the new arrow needs more stimulus (which it does), we could see another 10 to 15 trillion on the table in the coming months. The medium term key level on USDJPY stands at 135, which brings us back to the high of March 2002.