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.

Japan and the Yen, where do we stand now?

On October 31st, Governor Kuroda announced that the BoJ will raise (by a 5-4 majority vote) its bond-buying program. We saw the reaction since then; USDJPY soared from 112+ then to 120 (with a high of 121.86 on December 7). Some analysts think that the move was/is exaggerated, but if you put the figures on table, it looks reasonable to me. By announcing that the Bank of Japan will buy between 8 and 12 trillion JPY of JGBs each month, it means that it will purchase the total 10tr Yen of new bonds issued by the Ministry of Finance; in other words, full monetization. As a reminder, the central bank is the largest single holder of JGBs (with 20%+ of the shares), and could end up owing half of the JP bond market within the next 3 to 4 years.

With the country now in a triple-dip recession (GDP contracted by 1.9% in the third quarter) and the inflation rate slowing down for the fourth consecutive month in November (core CPI, which excludes volatile fresh food but include oil products, rose 2.7% in November, down from 2.9% in September and 3% in October), I see just more ‘power’ coming from Japanese policymakers. Elected in December 2012 as Japan PM (the seventh one in the last decade), I am convinced that Abe (and Kuroda/Aso) cannot fail this time and will (and must) continue to go ‘all-in- on his plan. That will mean aggressive easing, therefore constant depreciation of the currency JPY in the MT/LT. Remember the graph I like to watch: Central Bank’s total assets as a percent of the country’s GDP (see article It is all about CBs).

In fact, as many analysts have stated, the hit from the sales tax increase back in April turned out to be bigger than expected. The second one, which was set for October 2015 and would have seen a 2-percent rise to 10 percent, has already been postponed for early 2017 according to Abe’s announcement last month. When will the country work on its budget balance? As a reminder, Japan has been showing a 8%+ budget deficit over the past six years, which rose the level of its debt to a ‘unsustainable’ 230% as a share of GDP.

Another major problem that the third-largest economy will have to deal with in the long term is its population. The chart below (Source: the Economist) shows the evolution of Japan’s population from 1950 to 2055 (forecast). It is aging, and that is terrible news for all the pension or mutual funds as many people from the Japanese workforce will switch from being net savers to net spenders.

20141213_gdc700(Source: the Economist)

With a population of 127 million in 2013, the number of people is expected to fall below 100 million by the middle of this century due to the low birth of rate (total fertility rate of 1.4 in 2013).

In my article last month on the Japanese Yen History, I added a quick ‘technical’ chart and stated that we may see some take profit a 120 and that the pair should stabilize at around that level based on the downtrend line. And each time I have some discussion about the Yen, I always say there are two ways to play it:
– either keep it short (against USD or GBP) for those who are looking for a medium or long term view;
– or buy the pair (USDJPY) on dips if you try to catch nice trends. Don’t try to short it, unless you are really confident and have been doing it for a while. All traders I know are looking for buying opportunities on the pair.

Speaking of that, it looks to me that the core portfolio I have been carrying over the past few months now – Short EUR (1/2) , JPY (1/2) vs. long USD (2/3) and GBP (1/3) – has been quite profitable, and I still believe there is more room. At least, it makes sense on the idea I had about ‘monetary policy divergence’, with the US and UK considering raising rates (no printing/QE) while EZ and Japan aggressively printing with NIRP/ZIRP monetary policies. I will try to write a piece shortly on the Euro while I am working on my 2015 outlook.