On the surface, Japan is having the best of its times. Corporate profits are at a record high and the unemployment rate is at its 22 year low. However, we think Japan is on borrowed time. Japan owes its current prosperity to an unsustainable monetary policy. In our view, the BoJ is likely to reach its limit before the end of 2018.
The rising energy prices are starting to affect the trade balance of Japan. In January 2017, the trade surplus of Japan fell to 156 billion yen, equivalent to mere 0.3% of GDP in an annualized term. January 2017 also marks as the month Japan started to import LNG from the United States. As a result, energy imports from US more than doubled from a year ago. The news must be a godsend for the Shinzo Abe administration as it struggles to contain a potential trade war with US.
The Trump administration is stepping up its accusation that Japan is manipulating its currency to its advantage. Unlike other accusations, this one is in fact on the mark. Weakening yen was a campaign promise of Shinzo Abe when he became Japan's Prime Minister in 2012. It is also a common knowledge among economists that the exchange rate is the main transmission mechanism through which the quantitative easing of the BoJ affects the economy. Lined up alongside Chinese yuan and Euro, the Japanese yen is the most vulnerable as it is indeed significantly undervalued. The threat to attack the currency policy of Japan should prove to be a great bargaining chip for U.S. to extract concessions from Japan.
Japanese manufacturers seem to be in an expansive mood. In the last 5 months of 2016, Japan's industrial production and its exports rose by 4.0% and 3.9% respectively. The news could be a mixed blessing for the Japan though. With Prime Minister Abe due to meet President Trump on February 10, Japan does not want to give further ammunition to the accusation that Japan may be unduly benefiting from its trade with the U.S. In our view, Japan's position is at its weakest when it comes to defending the current weak level of yen. Japan's monetary policy has been implicitly targeting exchange rates in the last few years.
Corporate profits in Japan seem to be staging an unexpected comeback. The BoJ Tankan business condition DI for large manufacturers showed a first improvement in the last 6 quarters. Smaller sized companies, both manufacturers and non-manufacturers, also showed improvements in their business condition in December. These results strongly indicate that corporate profits in Japan may have renewed its peak in the current quarter. Corporate managers seems cautious through. Despite the likely record profits, they still decided to cut capital investments in FY2016 and they expect business conditions to worsen in the coming quarter. We tend to sympathize with their cautious view. Demands may have recovered somewhat in the second half of 2016 and yen did depreciate rapidly, but there is nothing hard to grasp on to have confidence in its sustainability. After nearly 4 years, Abenomics has very little to show in terms of structural reforms. We continue to think that the growth in the Japanese economy lack robustness and the potential reward for taking risks seem limited.
Japan finally caught up with other OECD countries in adopting SNA2008, the latest international standard for national accounts. Prime Minister Abe must be regretting not to have speeded up the efforts. The new set of statistics shows that the economy was growing much faster in 2014 and in 2015 than previously estimated. The inclusion of Research and Development as a part of capital expenditure, rather than intermediate inputs, seems to have boosted both the level and the growth rate of the economy. While we would caution not to confuse a change in the definition of GDP as an actual change in the economy, the newly found growth does imply that the higher value adding parts of the economy such as research and development are growing more rapidly than the rest of the economy.
Prime Minister Abe and President-elect Trump shaking hands in NY probably encouraged the market sentiment that all will be well with US-Japan relationship. Indeed, the market developments since the US election result Tuesday last week has been favorable for the Japanese policy makers. We do not think such a smooth sailing will last for long however. Unlike the time when President Reagan took office, a strong dollar is a wrong policy for US. Inflation is not a visible threat and the dollar has already appreciated by more than 30% in the last 5 years, pushing the dollar to more than 10% above the average since 1970. In our view, the yen depreciation that took place in the last 10 days would quickly reverse once President-elect Trump realizes that a weaker USD would be more beneficial for his electorate. While PM Abe may be able to preserve US-Japan military alliance, Mr Trump is unlikely to be the savior of Abenomics.
In the April-June quarter, corporate profits in Japan declined for the third consecutive quarter. The appreciation in yen is an obvious reason, but the weak domestic demand, especially that of private consumption, lies in the background. Corporate capital expenditures kept growing, but it is clearly losing momentum. Despite the surge in corporate profits in the last 3 years, Japanese corporate managers are diverting far less than usual to investments, reflecting their persistent pessimism in the long term outlook of the Japanese economy.
In cooperation with our partner in research, Europacifica, we are holding a conference call on The End of Kurodanomics on September 8. In our view, the Bank of Japan is likely to be forced to taper its Quantitative and Qualitative Easing program within the next few years. If so, the consequences could be disorderly. On this call, we examine the sustainability of the QQE program, economic and financial consequence of a sudden stop to QQE and its implication to financial investors.
It seems to be a bumper summer for loyal Japanese salarymen. Wages in Japan rose by 1.3% year on year in June, fueled by 3.3% rise in their summer bonuses. However, the talk of a good summer bonus may be painful for irregular workers in Japan, more than 1/3 of the total work force nowadays and mostly not eligible for bonuses.
The economic effect from the so called 28 trillion yen package is probably around 5 trillion yen, equivalent to 1% of GDP. The effect will be a short lived one in any case. As the government maintains its pledge to balance its budget by 2020, whatever the increase in spending in 2016, the government has to cut them right back in the following years. The stimulus was another misfired arrow, along with other growth enhancing measures that never materialized.
Judging from the torrent of economic data releases in the morning of July 29, the Japanese economy had a buoyant month in June. The unemployment rate fell to 3.1%, the lowest rate since 1995. More surprisingly, industrial production in Japan seems to be on an expansionary path this summer, suggesting that the yen appreciation so far in the year is within the level manufacturers can cope with.
It seems the 10 trillion yen fiscal stimulus was a mirage. According to a leak story carried by Nikkei on July 26, the government is planning to budget only 2 trillion yen in the supplementary budget, the bulk of which will be spent on old fashioned public works. Absent a large fiscal stimulus, a monetary expansion will likely have limited effects. The BoJ is likely to stop short of implementing a drastic easing measures this Friday.
The Japanese export to EU is gaining strength. The export volume to EU was up by 8% year on year in June, providing a rare bright spot among the generally stagnant export activities. However, it is unlikely that exports to EU alone could change the overall direction of Japan's export. Exports to EU accounts for mere 10% of the total, and the sustainability of its strength is also suspect as the world assess the Brexit impact.
The inbound international tourism in Japan saw a tremendous growth in the last three years. In terms of aggregate spending by foreign visitors, it has nearly tripled in the last 3 years. However, the industry is starting to feel the pinch from the appreciating yen. In the April-June quarter, the per capita spending by foreign visitors has fallen by 9.9% from a year ago. The per capital spending by Chinese nationals have fallen by 22.9%. While the number of foreign visitors are still growing, maintaining the growth rate would be a struggle now that the yen factor has turned from a tail wind to a head wind.
Core machinery orders, a leading indicator for private capital expenditure in Japan, dropped by 11.0% month on month in April. From a year ago, it is down by 8.2%. The private capital expenditure accounts for 14% of the Japanese economy and it was one of the demand components Abenomics counted on to fire up the growth in Japan. However, its growth has been slower than hoped for, and it seems to be losing steam now that the yen is turning to appreciate, hurting corporate profits in Japan. The misfiring of capital investment is one of the elements that led us to conclude Abenomics has already failed.
In April 2016, the regular wage index rose only by 0.2% year on year, a deceleration from 0.7% in March. The deceleration is disappointing. Until this latest reading, the regular wage index seemed to be on a moderate acceleration path. Real wage growth in April was slightly higher at 0.6% year on year, thanks to decline in energy prices. However, the rise is hardly a consolation to Japanese households who has suffered nearly 20% reduction in their real wages in the last 20 years. It is no wonder Japanese consumption are stagnant.
In the first quarter of 2016, corporate profits in Japan declined for the third consecutive quarter. Relatively to the recent peak, profits are already down by 16%. Another worrying sign we see is the continuing decline in sales. Sales have been falling for the past 4 quarters, for both manufacturers as well as for non-manufacturers. In our view, the continuing declines in corporate profits and sales are the symptom of the Japanese economy slipping back into deflation.
On balance, economic indicators released in the last few days suggest that the Japanese economy is doing slightly better than what we expected a few months ago. Exports and manufacturing activities were surprisingly solid in the first half of 2016. We suspected the labor market may be starting to cool in 2016, but recent data shows that it is continuing to tighten and there is a sign of modest wage inflation. However, we continue to believe that Abenomics is beyond repair and additional fiscal or monetary stimuli would only prolong the eventual reckoning of admitting the failure of Abenomics.
The consumption tax rate in Japan is currently scheduled to rise from 8% to 10% in April 2017. However, Prime Minister Abe seems intent to delay it by a year or two. In our view, he is wise to do so. The Japanese economy does not have the resilience to withstand the deflationary shock from such tax hike. If implemented, the tax hike will be the final nail on the coffin for Abenomics. A delay will not be sufficient to revive Abenomics though. The ultimate source of the failure of Abenomics lies in the lack of serious efforts to implement structural reforms. Delay or no delay, there is little chance that the current government would achieve the goal of reflating the Japanese economy.
Japanese exports had a moderate expansion in March. The export volume index rose by 1.9% month on month, mainly driven by the robust exports to EU. However, exports to US and to China, the mainstay of Japan's export, remained stagnant. With yen on an appreciation course, the path to growth and reflation seemed to have closed off for Japan
Japanese policy makers have maintained in the last 3 years that we should be seeing a persistent wage growth acceleration. We had some sympathy with the notion in the past, but we no longer think that we would be seeing further wage acceleration in Japan. The Japanese economy stopped expanding in the past 12 months and corporate profits are already shrinking. A few indicators suggest that the labor market is starting to cool. In our view, Japan is already derailed from the trickle down path to a reflation and a negative shock could bring Japan back to the vicious cycle of an economic stagnation and deflation.
March BoJ Tankan revealed that Japanese companies are starting to revert to deflationary mindsets. For fiscal year 2016, they expect their sales and profits to decline and their capital expenditure to shrink. Japan seems to be heading back toward deflation. Unfortunately, policy makers are yet to realize the depth of the problem. They are talking about a fiscal stimulus, but they seem to regard it merely as a convenient excuse to promise rewards to their supporters ahead of the Upper House election. In our view, policy actions will probably come too late and too little to save Japan from its descent to deflation.
Core machinery orders, the leading indicator for the private capital expenditure in Japan, expanded by 15% in January, boosting the monthly orders to the pre-Lehman shock level. However, the strength is most likely one-off. A closer inspection of the data reveals that the boost in January came entirely from the steel industry, an industry supposed to be suffering from over capacity. Despite the superficially strong machinery orders, we think it is more likely that the capital expenditure is peaking off in 2016.
Recent economic news indicate that the Japanese economy is already on a downward slope of its economic cycle. Retail sales have declined for three months in a row to January 2016. The January Industrial production result suggests that the Japanese economy may grow negatively again in the first quarter of 2016. G20 meeting over the weekend showed that the global economic environment is likely to remain unfavorable for Japan. Japanese policy makers are likely to respond with additional stimulus measures to try to cling to the notion that Abenomics can be put back on course. In our view, it is a futile effort. Unless Japanese voters are savvy enough to force a timely change in the Japanese public policy in the Upper House election this summer, the country is likely to spend 2016 just muddling through, in a downward trajectory.
So it is official. Japan had a technical recession in 2015. However, we would emphasize the word technical. With the rapidly shrinking working population, the potential growth rate of Japan is very close to zero. Having zero or moderately negative growth is no longer a big deal for Japan. In the last 5 years, Japan had three separate recessions. The likely responses from the Japanese policy makers reflect such business as usual nature of the recession. The Abe cabinet will likely compile a supplementary budget, but it will be half-hearted, with the aim mostly to win sympathies for the ruling party ahead of the Upper House election next summer, rather than boosting the economic growth. Similarly, the BoJ is unlikely to concede its position that Japan is still on its way to reflation. While we are not pessimistic on the near term growth outlook, we certainly do not think that Japanese is any closer to achieving a sustainable growth.
There is a sign the inflation expectation among Japanese households is waning off. In October, inflation expectation DI fell to the lowest level since April 2013, the month the BoJ initiated its current QE. While this development is a blow to the BoJ theory that inflation expectation is becoming firm in Japan, We think the BoJ will nevertheless maintain its hawkish stance. Japanese consumers have an adaptive expectation on inflation and the decline was probably inevitable as the sharply lower energy prices cause the inflation to fall. The household inflation expectation could be a factor in the wage determination process, but empirical papers on the issue tend to find that the labor market conditions, rather than the inflation, have dominant influence on the wage determination in Japan.
The BoJ kept its policy unchanged on October 7. Listening to the press conference given by the governor Kuroda, it seems unlikely that the BoJ would decide to ease before the end of the year. Mr Kuroda continues to believe that there is an ongoing reflationary trend present in Japan. While he admits the recent weakness in the industrial production, he attributes it to factors outside Japan and downplays its significance by stating that the manufacturing industry nowadays accounts for only 20% of the economy. Moreover, he seems emboldened by the robust corporate profits and the apparent willingness of corporate managers to invest in Japan revealed in September BoJ Tankan. His optimism seems genuine and we do not think he will change his assessment unless some unforeseen and significant negative shocks shake his confidence.
September Tankan delivered a breeze of positive news for the Japanese economy. The business condition of Japanese non-manufacturers improved between June and September, despite the prior market expectation that it would deteriorate. The decline in energy prices is likely to have contributed to widen their profit margins. The capital expenditure plans of Japanese large corporations have also been revised up. The BoJ is likely to see the news as a supporting evidence for their optimistic view on the economy.
The chances are that the Japanese economy had a negative growth in the July-September quarter. The industrial production results for August and the projection for September suggest a sizable decline of 1.1% in the quarterly industrial production. In the last 15 years, out of the 20 quarters when we saw a quarterly decline in the industrial production, 17 quarters saw a concurrent decline in the real GDP. A negative growth in the July-September GDP will mean a recession, that is, two consecutive quarters of negative growth. This news of a probable recession in Japan deals a heavy blow to Japanese policy makers who have maintained positive outlook on the economy. Will they respond with easing policies? In our view, the news of a technical recession certainly raises the probability of a fresh easing by the BoJ, but we think they will still maintain their passive attitude in the immediate future. A further deterioration in the stock market, and perhaps more importantly a rise in yen could force them. However, for now, we think the governor Kuroda cannot muster a majority of the BoJ board to implement an additional easing.
In August, the year on year change in the Japanese CPI excluding fresh food turned negative, -0.1%, for the first time since April 2013. However, we do not think this headline alone will push the BoJ into an additional easing. While the headline was weak, details on the CPI report in fact support the notion that there is a moderately inflationary trend in the Japanese consumer price. Unless other economic indicators start to deteriorate markedly, we do not expect the BoJ to ease any time soon.
The net export is likely to have lowered the July-September quarterly GDP growth in Japan by 0.2% point, judging from the trade data published today. While we think it is still unlikely, but if Japan did suffer a negative growth in the quarter, it will be a good wake up call for the policy makers to rethink their growth strategy for Japan.
The consumer confidence in Japan saw a modest pickup in August, giving hope that the consumers had a OK summer after a dismal spring. The Inflation Expectation index fell in August, falling to the low point since July 2014. The decline is yet marginal and the vast majority of Japanese consumers still expect prices to go up, but the declining trend in the last few months should be of some concern to the BoJ officials. The indicator deserves some attention in the next few months.
The Japanese economy shrunk by 0.3% in April-June. The growth is marginally better than the initial estimate for -0.4% growth, but hardly a positive news. Details reveal that the weakness of broad based. Private consumption and private capital expenditure both fell by 0.7% and 0.9% respectively. The level of private consumption in Japan is now lower than the prevailing level in the summer of 2012 when Abenomics started rolling. The negative sentiment of the Japanese consumers are striking. Back in the summer of 2012, Nikkei was below 10,000 and the unemployment rate was almost 1 percentage point higher. Somebody may be buying Japanese stocks, but Japanese consumers are certainly not buying Abenomics any more.
In July 2015, the regular (basic and overtime) wage rose by 0.6% year on year, an acceleration from the 0.3% in June. Total wage including the bonus component also rose by 0.6% year on year.
Japan grew by 0.6% in the January-March quarter, well above its potential quarterly growth of 0.1-0.2%. However, is it robust enough to comfort the BoJ that its 2% inflation target will be full-filled in 2016? Hardly.While we think it is achievable, any unexpected economic setbacks in the next 12 months could derail its achievement. If the growth turns out to be disappointing in the next two quarters, the BoJ should implement additional easing in the fall of 2015.
BoJ governor Kuroda was unusually evasive in the press conference after the policy meeting today. He declined to comment neither on yen, stock market nor on AIIB. He gave no clues as to when and how an eventual exit from QQE could be made. However, he was crystal clear on his determination to maintain the 2% inflation target, describing it as the origin of the current BoJ policy. That puts the speculation that the BoJ may lower its inflation target to rest. BoJ delayed the timing when it aims to achieve the inflation target to mid 2016. That is wise. However, we also note that a failure to reach its target in 2016 will expose Japan to a situation where Japanese public finance could no longer be viewed as sustainable.
Japanese export growth is failing to gather speed. In real terms, the quantity of exports in March is merely up 2% from the average of 2014 and still well below the prevailing level in 2012. By region, export to China seems particularly weak, with its quantity index trending down in the last few years. The results must have been a shock for the BoJ governor Kuroda. The weak yen was supposed to bring in stronger exports and capital expenditure, leading to a formation of an inflationary pressure within Japan. While we have seen no concrete evidence that this mechanism will not work, the time is running out for the BoJ. Unless we start to see signs of stronger growth momentum in the next 6 months, the BoJ may need to consider embarking on another round of stimulus.
Judging from the BoJ March Tankan results, the combination of the weak yen and falling commodity prices are apparently not enough for Japanese manufacturers to fully restore their profitability. In our view, the cost of an additional monetary easing still outweighs its benefit and the BoJ should sit tight. But if the incoming economic indicators in the next 6 months fail to deliver a picture of a growing and reflating economy, policy makers may need to ponder what stimulus measures are appropriate. Not meeting the 2% inflation target in 2015 is perfectly defensible in light of the falling commodity prices, but the BoJ will be putting its credibility on the line if the target is not met even in 2016.
The batch of economic data released on March 27 in Japan looked quite chilly, even cold. The 1.8% decline in retail sales in February was quite awful, and the sharp decline in new job offers to applicant ratio was alarming. On a closer inspection though, the data look somewhat warmer, say, lukewarm. The decline in fuel sales explains the decline in retail sales. Department store sales in fact had the best year on year growth in the last 11 months. We also found that the sharp decline in new job offers to applicant ratio could be a statistical glitch. All in all, the set of data from February was disappointing, but not so disappointing as for us to reconsider our upbeat outlook on Japan. We continue to think that the labor market in Japan is already in full employment and we are likely to see more visible sign of wage inflation by the end of 2015. Japanese corporations are already enjoying the fattest profit margin in many decades and corporate managers will likely expand their capital investment in 2015, fueling the growth in Japan. There is no need for the BoJ to ease. We think there is a high chance that the BoJ will achieve its 2% inflation target on the back of the rising wage inflation. Trying to bring such moment forward risks accelerating the growth too much, exposing Japan to a risk of excessive inflation in future.
In February 2015, exports from Japan grew by only 2.4% year on year, a significant slowdown from 17.0% year on year growth registered in January. The slowdown is largely due to the Chinese new year effects, but some of the slowdown should be regarded as genuine, stemming from the weakening in the economic activity in China. In February, the export volume from Japan to China hit the lowest level since the Lehman shock episode in 2008-9. On the import side, while the import value declined in February, the decline is entirely due to the fall in commodity prices. The import volume in fact rose for two consecutive months through January and February, a reflection of an acceleration in the economic activity in Japan, in our view.
The wage inflation seems to have finally arrived in Japan. In January, regular wages rose by 0.9% year on year. It may seem pitiful for an international observer, but in Japan it is the highest rate yet for well over 10 years. In our view, this is only the beginning of goods news for workers in Japan. Companies are already struggling to find workers. In January 2015, there are almost twice as many new job offers as new job seekers. We expect the wage inflation to gradually accelerate through the course of 2015-16.
The last quarter of 2014 was the most profitable quarter for Japanese companies in the last 30 years. Collectively, they made 18 trillion yen, equivalent to USD150 billion in the quarter, the largest profits ever made in one quarter. Perhaps more significantly, their profit margin was the highest in 30 years. Manufacturers did particularly well, with their profit margin the highest in 60 years, going back to 1954. Moreover, they are likely to do even better in the first quarter of 2015. The real export grew by 5% month on month in January. The falling commodity prices mean their profit margin must have widened too. For now, the manufacturers seem to be racing ahead, but their high profitability is likely to have a positive ripple effects throughout the Japanese economy in the coming quarters. 2015 is looking quite rosy for Japan Inc.
We now see the Japanese economy growing by more than 1% in 2015 and by more than 2% year on year in 2016. We see three important factors that brightens our economic outlook. They are, the decline in commodity prices, the sign of robust growth in exports and the sign of pronounced tightening in the labor market. The decline in commodity prices brings a sizable saving for the Japanese households and corporates, worth 0.7 to 1.4% to GDP. Export volume has grown by 12% in the 5 months and the increased exports should exert positive ripple effects throughout the economy. With the ongoing tightening in the labor market, the unemployment rate will soon breach the NAIRU rate and will cause a wage inflation. With such bright outlook for the economy, there is hardly any need for the BoJ to implement additional easing.
Made in Japan is making a comeback. Encouraging companies to invest and produce in Japan has always been a core message of Abenomics. More than 2 years into Abenomics, companies seem to be starting to follow the lead. Export volumes started to grow robustly in the last 4 months of 2014. Industrial production is picking up. Now, we are finally seeing some sign of expansion in the private capital spending. Core machinery orders, a leading indicator for the domestic capital investment, grew by 8.3% month on month in December. That alone is not conclusive, but in combination with anecdotal stories and survey results such as BoJ Tankan for capital investment plans, we think the balance of evidence points to much firmer outlook in private capital investment. Expansion in production activities should also entail larger demand for labor. In our view, the labor market in Japan is already at a full-employment. Additional demand for labor should help fuel wage inflation in Japan. We expect wage inflation to exceed 1% by the end of 2015 and 2% inflation target to be reached in 2016.
The news from the December wage report was encouraging. Regular wage rose by 0.4% year on year, accelerating from 0.1% in November. While the year on year growth is still pitiful, it is relieving to confirm that the wage disinflation that took place since last summer was short-lived. We expect the wage growth to accelerate in the next 12 months, rising above 1% year on year by the end of 2015. The unemployment rate has declined to 18 years low and it is a matter of time that the Japanese companies start resorting to raising wages to fill their vacancies.
Looking at the December labor market data today, we felt we could almost hear the sound of the labor market tightening in Japan. In December, the unemployment rate fell to 3.4%,18 years low, and the job offers to applicant ratio rose to 1.15, 23 year high. Even more remarkably, new job offers to applicant ratio rose as much as 0.13 point to 1.79. A single month rise of 0.13 point has not happened in Japan since 1976. As we pore over the data, we see that while job offers are certainly robust, it is also the shrinkage in the labor supply that is causing the labor market to tighten. While is the labor supply shrinking? A simple reason. In 2014, Japanese population in the age bracket 15-64 shrunk as much as 1.2 million persons. In our judgement, the tightening in the labor market is likely to even accelerate through the course of 2015. Encouraged by yen weakness, manufacturers are finally starting to expand their production in Japan and they require more workers in 2015. Where does it lead to? Wage inflation. There are pundits who argue that wage simply cannot rise in Japan. They need to open their eyes and look at the history beyond the last 20 years. In 1980s, wage was rising at an average rate of 3.7% in Japan. Wage inflation merely lags behind the economic activities and inflation by a year or two. In our view, the 2015 is likely to be remembered as the year wage started to rise.
The news from the December trade data was encouraging. Japan's export was up 12.9% year on year, the highest growth rate for the past 12 months and beating the prior market expectation. While the export volume is not expanding by much, the weak yen is fattening up the profit margin of Japanese exporters to a historical high. The high profitability is enabling manufacturers to raise the wage of their employees. In November, the average wage growth among manufacturing workers were 1.5% year on year. In our view, it is just a matter of time that the wage growth would spill over to other industries.
Among the torrent of data released on December 26th in Japan, we point to the rise in job offers to applicant ratio and the robust outlook for industrial production in December and January as the news worth paying attention to. The job offers to applicant ratio rose to 22 years high in November. In our view, it is a matter of time that the tighter labor market condition would lead to higher wage inflation in Japan. Manufacturers see their production expanding by 9% accumulatively in this December and January. While the plans are too robust to be true, it supports a notion that the weak yen may be finally persuading Japanese manufacturers to produce in Japan. On the inflation front, dis-inflation trend is becoming visible. We do not think the BoJ needs to be concerned though. Lower commodity prices is a boon to the Japanese economy. The BoJ merely needs to sit tight and let the positive effects from lower energy prices re-energize the Japanese economy.
Our outlook for the Japanese economy has substantially changed in the last three weeks. The change is most pronounced for 2016 where we are revising up our forecast from 0% growth to 1.2% growth. By effectively cancelling the sales tax hike and adding fiscal stimulus, the fiscal policy in Japan will remain as loose in 2015-16 as in 2013-14. The monetary policy is being loosed further in 2015-16. With the QQE2, the BoJ is now buying 150% of JGB issued by the government, up from 90% under QQE1. Pundits may argue that the loose-loose fiscal and monetary policy risks destroying the credibility of Japan to maintain its fiscal sustainability. While we agree, we think it is a gamble Japan needs to take. Defeating deflation is a pre-requisite in regaining fiscal sustainability and the tax hike in 2015 could have destroyed the last chance for Japan to inflate itself.
The Japanese economy contracted by 0.4% quarter on quarter (QoQ) in the July-September quarter. In our view, there is no need to be depressed by the weak result though. Government officials are already responding to the news by adding stimulus. The monetary stimulus implemented by BoJ should have significant effects to boost the economy through higher equity prices, lower yield and weaker yen. PM Abe is about to announce fiscal stimulus measures. Some may criticize him for not following through with fiscal reform plans, but we would rather praise him for his decision. Defeating deflation is the top priority for Japan and a requisite for Japan to regain fiscal health. We also like to note that there are signs that Japanese economy is already starting to recover from the blow from the sales tax hike. Retails sales have expanded robustly in the last two months and there are signs that corporate managers are warming up to implement capital spending. The cancellation of sales tax hike should further help them gain confidence. If the anticipation of weak GDP figures helped Mr Abe make that decision, it was a blessing for Japan.
With a hindsight, October was the last month the BoJ conducted its JGB purchase operation under the previous guideline announced in April 2013. In October 2014, the BoJ bought 7.8 trillion yen of JGBs, with their average maturity at 6.4 years. From November on, the BoJ will be purchasing JGBs under the new guideline, 8 to 12 trillion yen per month with their maturity 7-10 years on average. By expanding the amount and extending its maturity, the BoJ will be almost doubling its firepower of its JGB purchase when measured in duration risk. With the short to medium term interest rates close to zero, the BoJ is targeting to push down long term interest rates. 10 year rate is already as low as 0.45%, but 30 year rate, at 1.52% as of November 6, it offers some room to be compressed.
Kuroda knows when to go ALL in. Bank of Japan unexpectedly eased today (Oct.31) by announcing a massive expansion of their asset purchase program. The bank will increase its net-purchase of JGB from 50 trillion yen per year to 80 trillion yen and reallocate its purchase toward longer and riskier JGBs. In our estimate, the BoJ doubled its purchase of JGB duration risk by today's measure. The BoJ is effectively betting all it has to achieve its inflation target and to urge fiscal policy makers to regain the fiscal sustainability of Japan. In our estimate, it would have been 2020 when the BoJ owns 50% of the JGB market. With today's announcement, the BoJ could end up owning 50% of JGB market by as early as in 2018. The BoJ is basically declaring that Japan will need to fix its long term problems by 2018, or risk becoming a failed nation.
Japanese manufacturers ended the July-September quarter on a positive note, with production increasing by 2.7% month on month (MoM) in September. However, the positive finish does not change the fact that production has declined for two consecutive quarters, putting Japanese manufacturers in a technical recession.
Retail sales results in September provided another hint that Japanese consumers are recovering from the shock caused by the sales tax hike in April. In September, retail sales rose by 2.3% year on year (YoY), the third consecutive month with positive YoY growth. After a seasonal adjustment, retail sales grew as much as 2.7% from August. Compared with its average in 2013, the retail sales level in September was 3.8% higher. In our view, the Japanese consumers seem to be breaking free from the negative shock caused by the consumption tax rate hike in April.
September trade data provided some moderately positive news for Japan. Japanese exports in September was up 6.9% year on year (YoY), the highest growth in the last 8 months. Exports to China was up 8.8% YoY, exports to US was up 4.4% YoY. After a seasonal adjustment, Japanese exports are at its largest level since October 2008.
A new hope is emerging that the corporate Japan is becoming more active in its capital investment. Core machinery orders, a leading indicator for the private capital expenditure in Japan, expanded by 4.7% month on month in August, marking the third consecutive monthly expansion. The outlook for corporate capital investment has been ambiguous. Various surveys, including BoJ Tankan, suggested that companies in Japan are planning to increase their capital expenditure, but there has been no matching evidences in the actual statistics. The latest machinery orders data alone are still insufficient to become positive on the outlook, but it does give a glimpse of hope that the private capital expenditure may start to contribute to the growth in Japan while consumers suffer under the weight of sales tax hike, both in 2014 and in 2015.
Tankan results were disappointing. The business condition DI deteriorated for most of business categories except for large manufacturers. The results show that for the majority of Japanese businesses, their profitability continued to deteriorate between June to September, on top of the large deterioration they suffered between March and June. Some may argue that yen weakness is hurting SMEs and non-manufacturers. Data from Tankan does not support such notion. Input price DI in fact improved for non-manufacturers between June to September. Instead, it was the decline in output price DI that seem to be hurting their profitability. In short, it is again the deflation that is hurting corporate profitability.
Judging by the flow of economic data released this morning, the Japanese economy seems to be regaining its balance. Retail sales seems to be recovering, the labor market remains tight, and the most assuringly, the wage growth seems to be slowly but consistently accelerating. However, this is no time for policy makers to relax. With another installment of sales tax hike around the corner, private consumption alone cannot deliver growth in Japan. Ideally, either export or private capital expenditure should start to grow, sharing the burden of lifting growth. Instead, Japanese manufacturing is in a technical recession with its production declining for two quarters in a row. In our view, the current state of the Japanese economy seem quite fragile to some downside shocks, not so dissimilar to its state in 2007. In this environment, it is crucial that the Bank of Japan shows its commitment to support growth in Japan, whatever it takes. To enhance its commitment, the bank should publish its outlook for its balance sheet in 2015 in the next policy meeting in October.
There is a mounting evidence that the Japanese economy is not inflating any more. In August, core consumer price inflation decelerated from 3.3% in July to 3.1%. The deceleration also likely continued into September. The advance CPI report for Tokyo area shows that the core CPI inflation decelerated from 2.7% in August to 2.6% in September. While it would be premature to start to worry about a return of a deflation, the apparent disinflation trend should be concerning to the BoJ.
Imports shrunk by 1.4% from July in August. Imports obviously correlate with domestic demands and the news points to a concern that the growth in July-September may be much weaker than expected. Policy makers do not seem eager to implement stimulus measures though. Fiscal policy makers maneuver is constrained by their desire not to cancel the sales tax hike in 2015. BoJ officials are concerned over its expanding balance sheet. In our view, it is no time for complacency for the BoJ. By dithering, they are risking all the efforts they expended since Kurodanomics started.
The Japanese economy shrunk by 1.8% quarter on quarter, according to the revised estimate published on September 8. The estimate is a slight downward revision from the initial estimate published on August 13 that calculated the shrinkage to be 1.7% qoq. The shrinkage in the private capital expenditure was re-estimated to be larger than initially estimated. In the light of weak economic data received so far, we suspect that policy makers are starting to be worried. However, they are unlikely to consider adopting stimulus measures until early 2015. Why? It is because as soon as they start discussing on the stimulus measures, the first question they would face is why they would not cancel the consumption tax rate hike to 10% in 2015. In the press conference on September 5, BoJ governor Kuroda supported the tax hike in 2015 and said the negative impact from the tax hike can be dealt with later. In our view, it sounds dangerous as it is tremendously hard to change the direction of the economy once it starts to go south. However, that seems to be the risk Japanese policy makers are willing to take to make the tax rate hike final.
Prime Minister Shinzo Abe reshuffled his cabinet ministers and LDP leadership positions on September 3, 2014. There will be no change in the direction of Abenomics. Finance Minister Aso remains in his place and he will continue to exert an expansionary bias on Japan's fiscal policy. The most important change in this reshuffle is the removal of Mr Ishiba from the position of Secretary General of LDP. Mr Ishiba almost beat Mr Abe in the LDP leadership contest back in 2012 and he continues to be an immediate threat to Mr Abe. With Mr Ishiba reduced to occupy a minor ministerial position, Local Economy Revitalization Minister, Mr Abe has succeeded in solidifying his political stability.
The wage report for July delivered a set of good news for the Japanese economy. Total wage grew by 2.6% year on year (YoY) in July, the highest growth rate since January 1997. The YoY growth rate in the basic wage was much more sober at 0.7% YoY in July, but the bonus wage component grew as much as 7.1% YoY, boosting the total wage growth. The 0.7% growth in the basic wage is also not insignificant. As stale as it may seem from an international perspective, it is the highest growth in Japan since March 2000. The July wage report provides a timely relief for policy makers who have been starved of good news recently. Policy makers can now claim that wage is gradually catching up with the consumer price inflation and therefore, their logic goes, the Japanese private consumers can take another beating from the sales tax hike in 2015.
Most of the data published today point to a stagnation in the economic activities in Japan. Retail sales contracted in July by 0.5% from the previous month. Household Survey reported a shocking 5.9% year on year decline in the real consumption in July. The unemployment rate rose for the second consecutive month. Most of all, the result of the July industrial production data suggests that the production could contract in July-September quarter. If it does, it will be the second consecutive quarter in decline, putting the industrial sector in Japan into a technical recession.
Japanese exports expanded modestly in July. On a seasonally adjusted basis, the value of exports expanded by 1.8% between June and July. Japanese exports are far from robust though. The export volume, after stripping away price effects, has been steady declining since late 2011 and it remains roughly 10% below the prevailing level before the 2011 earthquake. It almost seems that Japanese exporters went through an irreversible process in 2011.
The average wage in Japan rose by 1.0% year on year (YoY) in June this year, recording the highest growth rate in 4 years. The growth rate in the basic wage component remained stale at 0.2% YoY, but the summer bonus component rose by 2.0% YoY, adding a boost to the total wage growth. While the news is positive, we must note that the even this 1% growth is nowhere near sufficient to make up for the inflation though. The wage report estimates that the real wage after accounting for inflation is still falling at the rate of 3.2% year on year even with the 1% rise in the nominal wage. While the expansion in the employment base (up 1.5% year on year) and the recovering consumer sentiment may keep the private consumption from plunging further, it is unlikely that consumers play the role of growth driver for the Japanese economy until VAT hike effect fades away.
The growth in Japan is undershooting the prior expectation The latest GDP data was weak, showing that Japan shrunk by as much as 1.7% in April-June quarter. What are the consequences of the weak Q2 GDP result? First of all, the current government growth outlook of 1.2% for the fiscal year 2014 is now virtually impossible to hit. It will needs to be revised down to below 1%. Then, will the sub-1% growth prompt either the government or the BoJ to implement stimulus? The answer to this question is probably a NO. The government does not want to admit a need for a stimulus as it prefers to avoid the discussion of a possible cancellation of the sales tax hike in 2015. The BoJ, on the other hand, is concerned to overextend its monetary stimulus. Where does it leave Abenomics? While the July-September quarter is likely to register a positive growth on the back of a rebound from April-June, there is not assurance that the growth will come back from October-December onward. Japan is likely to enter 2015 on a weak growth momentum.
The retail sales in Japan in June was disappointing. 3 months after the VAT hike, the year on year growth still failed to turn positive. Retail sales fell by 0.6% in June from a year ago. Department store sales continued to be severely affected, down 3.3% from a year ago. It was a disappointing result for those who were hoping to see a sign of consumers recovering from the negative shock from the VAT hike in April. The outlook for retail sales is slightly more positive though. Consumer confidence does seem to be recovering through to July and the summer bonus this year should be the highest since 2007. The recent stock market upturn should also help consumers spend in the summer.
The consumer price in Japan on the whole seems to be maintaining a moderate rising trend in the 3 months after the VAT hike. The nationwide CPI excluding fresh food, the official target for the Bank of Japan, rose by 3.3% year on year in June. It is a slight deceleration from the 3.4% inflation in May, but a mere 0.1% point deceleration is hardly an evidence of a new trend yet. After seasonally adjustment, the same CPI measure is reported to have risen by 0.2% between May and June, showing a continuing presence of an inflationary trend.
International trade activities in May were weak with both exports and imports shrinking from April. After seasonal adjustment, exports fell by 1.2% month on month (MoM), and imports by 1.3% from May. While the news of stagnating exports is nothing new, the decline in imports in May was quite surprising. Imports had already fallen by 9.9% MoM between March and April, and most economists including us were expecting a modest expansion in imports in May. The continued decline of imports in May suggests that the weakening in the economic activities in Japan may have continued into May. Japanese policy makers have been maintaining an optimistic view that the VAT hike in April will only have a transitory negative effect. The weak imports figure from May suggest otherwise.
Total wage in Japan rose by 0.9% year on year in April. While the rate of growth is one of the highest in recent months, it still pales against the CPI inflation rate of 3.4% year on year in the same month. Using a modified inflation measure, the statistical agency that releases the wage data put the real wage to have declined by 3.1% year on year in April. The base salary, without the overtime and bonuses, fell by 0.2% year on year, even on a nominal term. Thus, all the talk about base salary increases for employees in large companies must have been exception. With such severe decline in real wage, it is difficult to envisage how private consumption in Japan could maintain real expansion in the rest of 2014. Even outside wage income, Japanese households are not faring better either. Public pension has just been cut by 0.7% in April in order to reduce deficits in Japanese pension system. While policy makers tend to remain hopeful that consumption should recover toward summer, we find it difficult to conceive why that should be the case. We expect private consumption to remain largely depressed in the rest of 2014.
It seems consumers' behavior before and after the VAT hike is virtually the same in 2014 as in 1997. In April 2014, retail sales fell by 4.4% year on year (YoY), comparable to the decline of 3.8% YoY in April 1997. While Japanese mass-media and policy makers tends to downplay the negative effects of the VAT hike on consumption, the effects so far seem just as bad this year as in 1997. In our view, there is no wonder though. Japanese household will be suffering severe decline in real income this year. We expect wage growth in 2014 to be 1.2%, well below the CPI inflation of 2.7%. Situations are even worse for pensioners who now account for 25% of the whole population. From April 2014, public pensions were cut by 0.7%. Stagnating stock market will also not help Japanese pensioners. Policy makers tend to maintain that consumption would recover from summer. We think such assumption are overly optimistic.
International tourism is one of the few promising businesses that grew strongly in the recent years in Japan. Foreign visitors to Japan doubled in the last decade and reached 10 million people for the first time in 2013, led by an increase of Asian visitors. The Japanese government has set an ambitious goal to increase the foreign visitors to 20 million in 2020 and 30 million in 2030. It is not an unachievable goal, considering the number of visitors of other countries and expected further improvement of income levels in Asian countries.
Japan’s seasonally adjusted trade deficit improved significantly in April, shrinking from 1.6 trillion yen in March to 0.8 trillion yen in April. The improvement was caused by a reduction in imports, rather than by an expansion in exports though. Imports fell by 10% month on month between March to April, causing the deficit to shrink. The decline in imports in April is likely to be a reflection of how economic activities in Japan weakened in April with the VAT hike.
There is a sign that Japan Inc. is accelerating their capital investment within Japan. Core machinery orders, a leading indicator for the private capital expenditure in Japan, grew by 19% month on month (MoM) in March. On quarterly term, core machinery orders grew by 4.2% quarter on quarter (QoQ) in January-March 2014, accelerating from 1.9% QoQ in October-December 2013. The acceleration gives a hope that a growing demand from private capital expenditure could offset the loss of demand from private consumption due to VAT hike in 2014.
Consumer confidence index continued to deteriorate in April, down to 37.0 from 37.5 in March. Through the course of 2012-2013, consumer confidence index consistently improved between December 2012 and September 2013. However, since October 2013, around the time PM Abe finally decided on the VAT hike, the index started to deteriorate. The index has now deteriorated back to the level before the advent of Abenomics. The index tends to lead consumption trend and it is one of leading indicators adopted by the Cabinet Office for their official composite leading indicator. While it would be premature to expect a recovery in the index in April, just after the VAT has risen, we will find if concerning if the index continues to deteriorate to May.
Aside from the robust 1.5% quarter on quarter (Q0Q) headline growth, there were other encouraging news for Japan in the GDP report. Private capital expenditures and exports recorded their highest expansion in two and half years, by 4.9% QoQ and 6.0% QoQ respectively. Through the course of 2013, both private capital expenditure and exports remained stagnant, seemingly unresponsive to weak yen and easy monetary condition. The robust growth of private capital expenditure and exports in the January-March quater shows that they may be finally starting to grow. If that is the case, it is particularly encouraging for Japan as they could fill the demand gap left by the likely weakening of private consumption after the VAT hike.
The current account deficit of Japan hit the new record in March 2014. Both the trade deficit and the current account deficit in March hit the new historical record of 1.89 trillion yen and 789 billion yen respectively after seasonal adjustments. In our view, the gap between the weak external demand and the robust domestic demand lies at the heart of the deterioration in Japan's external balance. Despite the weakness in yen, Japanese exporters are not using the advantage to bolster their export volume. On the other hand, imports are continuing to expand, reflecting the robust domestic demand. Weaker yen is also inflating the nominal value of imported energy. Japan's current account deficit also indicates that Japanese economy may be reaching its production limit. Abenomics policies have succeeded in stimulating demand, but it has done little to increase its supply capacity. In our view, the deficit will likely continue until Japan falls back into a recession.
The Japanese labor market continues to heat up. The unemployment rate in March 2014 was 3.6%, unchanged from the previous month but still one of the lowest rate since 1998. We would judge that Japanese labor market is becoming sufficiently tight that employers will need to increase wages to entice new hires. New job offers in March was up by 5.4% from a year ago, but new job applicants are down 9.7% from a year ago. Able bodied are becoming increasingly scarce in Japan.
On April 30, Ministry of Land published the result of Residential Property Price Index for January. Contrary to anecdotal impression we receive from the Japanese media, Residential Property Price Index indicates that there is less heat in the housing market. Prices for condominium are still maintaining an upward trend, but the land/detached house price is falling.
Wages in Japan rose by 0.7% year on year (YoY) in March 2014. While the rate of growth is one of the highest in recent months, it still pales when compared with the rate of inflation. In March, National CPI rose by 1.6% year on year and we think the inflation will accelerate to 3% in April. Judging from news reports on wage negotiation for large companies in Japan, Wage growth will most likely accelerate from April, but we think the wage growth will probably be between 1.0 to 1.5% at most. In our view, private consumption is in a tough spot in 2014, with real wage falling, stock market stagnating and Japanese household knowing that sales tax will probably rise again in 2015.
It seems consumers' behavior in the run up to the VAT hike in April 2014 was almost the same as in 1997. In March 2014, retail sales rose by 11.0% year on year (YoY), comparable to the rise of 12.4% YoY in March 1997. The behaviors of sub-sectors are also comparable. The critical question now is how similar the rest of 2014 will be to 1997. We are not optimistic. With wage barely rising, how can consumers keep shopping with 3% higher price tag? While Japanese media tend to play up the likely wage gains from April, we do not think the rise will be much more than 1%. In comparison, wage was rising close to 2% in 1997. It is true that there are a few elements making the odd better for 2014 than for 1997. The corporate balance sheet is in much better shape now and the Japanese financial system seem more stable now than in 1997. On the other hand, the fiscal situation is far worse now than in 1997. Japanese household knows that there is another VAT hike in 2015. With the shrinking population, Japan has much lower growth prospect now than in 1997. In our view, there is as much to worry in the second half of 2014 as there was in the second half of 1997.
Consumer price in Tokyo rose by 2.9% year on year in April, a 1.6% points jump from 1.3% YoY in March. Tokyo CPI excluding fresh food rose by 2.7% YoY in March, a similar 1.7% points jump from 1.0% YoY in March. The VAT hike in April was expected to push up the price in April by 1.7% points if the tax hike was fully transferred and the result shows that was exactly what happened. Policy makers are likely to regard the result as a positive sign that Abenomics is working as expected. The fact that retailers decided to fully transfer the VAT onto consumers shows their judgement that consumers sentiment would be sufficiently robust. BoJ is likely to regard this news as one of the evidences that Japanese economy does not require additional easing measures for now.
Japan’s seasonally adjusted trade deficit in March 2014 was 1.7 trillion yen. The robust domestic demand is pulling in imports while exports continue to stagnate, failing to take advantage of the weaker yen. Why is Japan suffering from trade deficits? In our view, there are two principal reasons. The first is the under-capacity in Japan. Private capital investment has never recovered after the collapse following the Lehman shock. The second is the surge in domestic demand since 2013. The robust domestic demand fueled by consumption and public investment are overwhelming the production capacity in Japan, necessitating imports from overseas.
There is a puzzling polarization trend in the residential property market in Japan. According to Residential Property Price Index (RPPI) published by Ministry of Land, the condominium price index rose by 9.1% year on year (YoY) as of December 2013, while that for land/detached house price fell by 2.3% YoY in the same period. As the aggregate value of land/detached house outweighs that of condominium, the overall RPPI is still falling. This result is in stark contrast to the common perception that real estate prices in Japan are starting to rise because of Abenomics. What is the true state of the real estate market in Japan?
Going through the barrage of Japanese data published on February 28, we cannot help feeling somewhat melancholic. All the data point to an economy enjoying a boom. If left alone to run its course for another 12-18 months, Japan could finally exit from the 15 years long deflation. But the sad likelihood is that the good days of Abenomics is about to end. Thus the melancholy.
Japan Cabinet Office revised down its estimate for 2012 real GDP growth rate from 2.0% to 1.4%, a sizable downward revision. When we examined the details of the downward revision, we see that the Cabinet Office may be similarly overestimating the growth rate for 2013. It is likely that Japan is not growing at the rate of 2.4% year on year in July-September 2013 as the latest estimate suggests. Such concerns have an implication for the BoJ. Probably, the BoJ needs to worry less about a possible overheating in the Japanese economy and it should continue to focus more on reflating the economy.
The Japanese government developed and started to publish a Residential Property Price Index (RPPI), Japan's equivalent to the Case Shiller index in US. This primer explains the features of the statistics, how it differs from existing statistics on the real estate market in Japan.
We are happy to announce that we are starting to publish our estimates for the average duration of JGBs held by the Bank of Japan. We believe this information is essential in order to assess the effectiveness of, as well as the risk from, the BoJ’s Quantitative Easing (QE) policy under its new governor Haruhiko Kuroda.