Was it a Hail Mary pass from Japanese Prime Minister Abe?

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“Our doubts are traitors and make us lose the good we oft might win by fearing to attempt.”

   William Shakespeare

Commentary & Analysis

Was it a Hail Mary pass from Japanese Prime Minister Abe?

Did you read about the Bank of Japan (BOJ) surprise last night? Let me just say, I was surprised, as I have been expecting the yen to strengthen.

This is likely the mother of Hail Mary passes by Prime Minister Abe & Co.  Success or failure of his government hangs in the balance, I suspect.  I'll explain in a moment.

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Now back to the BOJ ...

Overnight they launched a brand new stimulus.  It is a double-barrel bazooka blast.  Blast number one: The BOJ plans to expand the monetary base by 80 trillion yen ($724 billion); and Blast #2: A government panel approved plans for the giant Government Pension Investment Fund (GPIF), reported size is $1.2 trillion, to raise its holding of domestic and foreign stocks to 25 percent of its portfolio; that is up from 12 percent now held for each category.   

Stocks rocketed in Japan and elsewhere on the news.  The Japanese yen crushed lower.

Just a coincidence, or is there something more here given that just two days ago the Federal Reserve ended their own quantitative easing program. Was this the BOJ being worried and/or a coordinated act?  That inside information would have paid off big!!!

As we've repeated many times throughout the Fed's era of QE and low-interest rate policy, other countries will feel the pain once the Fed exits stage left.

Japan is an obvious victim at a very dangerous phase of Prime Minister Abe’s three-arrow program that seems to be floundering.

Japan is in a constant battle with deflation/inflation.  On the horns of a dilemma they seem to hang.  On the one hand, success to date in weakening the yen and creating domestic inflation, by driving up import costs, has been successful (thank goodness oil prices have been falling during this process).  But on the other hand success in creating inflation has led to extreme pressure on local importers who are now screaming the yen is too low and costs are killing them.

Bloomberg 30 Oct 2014: Prime Minister Shinzo Abe said on Oct. 7 that yen depreciation is hurting small companies and households, almost two years after triggering the currency’s slide with a call for unlimited monetary easing to end deflation. Little more than a week later, Kuroda said a weak yen can depress the non-manufacturing sector and real incomes, before reiterating on Oct. 28 that declines in the currency have been positive overall for Japan’s economy.

“A 105-110 yen range would make everyone in Japan happy, as it’s the closest thing to being just right for the widest swath of the economy,” Tohru Sasaki, the bank’s [JPMorgan Chase] head of Japan rates and currency research and a former Bank of Japan official, said by phone today. “We’ve seen that the threat of an exchange rate weaker than 110 yen per dollar made a lot of people uneasy, so if the yen were to strengthen to 105 per dollar, I doubt we’d hear any complaints.” 

The above recent comments from the Prime Minister, the BOJ chief, and a focused Japan analyst, plus the reality on the ground, help explain why there was such surprise by the BOJ’s decision to flood the market with more yen today…and nothing moves prices more than surprise. 

The reality on the ground is Abenomics is in trouble.  Politically there are rumblings about getting rid of Abe.  We know small business isn’t happy.  And even though there has been a huge depreciation in the yen since Abe took office, exports have not responded—I think that is a reflection of the lack of real aggregate demand in the global economy and it’s structural as pointed out here many times before. 

 But the crux of the problem is this: real income for Japanese households has to improve in order for Abe’s third-arrow of productivity and real growth to take hold.  So far, that hasn’t happened. 

Given the fact a weaker yen to date hasn’t been supportive of Abe’s policies; at least as it comes to the hard stuff of structural reform, it is surprising the BOJ would acquiesce in this way.  Does it hint of desperation to you?

 The other view of course is Japan needs more inward investment in order to stimulate demand and raise productivity; thus driving incomes higher in the process.  So maybe the bet is a rising stock market (raising collateral values) will help to drive more investment into Japan.  But one wonders if this will matter given that corporations already seem to have plenty of cash to invest locally—shouldn’t they know better if real opportunities are present?

It is a big bet by Abe & Co. They risk higher domestic inflation in hope investment triggers real reform and higher real income. 

The end of the Fed’s QE and potential of falling dollar liquidity likely factored large into today’s decision (and I am sure the Fed isn’t unhappy to see all the shorts get squeezed out of stocks).  But Japan cannot go it alone.  If the US economy slows or stagnates, it is unlikely this latest bet will be successful in Japan. 

How much patience will Mr. Market allow to determine if the third arrow is hitting its mark?  If improvement in the real economy doesn’t materialize soon (a nebulous and relative term indeed), I suspect there will be a major repatriation back into Japan.  And unless the correlation between Japanese repatriation and the currency changes—possibly because of a Japanese Government Bond (JGB) crisis—the yen will strengthen and surprise a whole lot of people as the new government prepares to resume office.

USD/JPY versus Nikkei Stock Index versus 10-year Benchmark Bond Yield (JGB) Inverted:  A trifecta.  Currency weakens, stocks and bond prices rally (yields fall)….the bond correlation with the currency has broken down a bit.  However the negative correlation between Japanese stocks and the currency seems quite intact.  Abe’s failure likely means all this reverses.  Success and USD/JPY 125 may be in the cards after all…

 Happy Halloween! 

Jack Crooks

President, Black Swan Capital

www.blackswantrading.com ,


Twitter: @bswancap