Abeconomics, Nikkei, Dollar Yen and tapering

The impact of US monetary policy on global markets remains large. The impact on the Japan financial markets is somewhat counter-intuitive, especially in the light of Abeconomics. Tighter US monetary policy in the face of aggressively easier Japan monetary policy should, prima facie, weaken the Yen. Given the export-oriented aspect of Japan equities this should boost the latter.

The prospect of Abeconomics back in December 2012 did trigger a trend weakening in Dollar Yen and corresponding rally in the Nikkei. It was the prospect of tapering in the US that ended the two trends back in May. This is not a self-evident logical development. The prospect of tighter US monetary policy might reasonably have been expected to accelerate these trends. Indeed it will, and soon.

The end of the Japan market trends back in May was quite logical if all the facts are known and the nature of market dynamics understood. In part it reflects the perceived sensitivity of the Japan economy to global growth. Tapering was taken to mean that one major stimulus to global growth was likely to be removed. A neat narrative but does not really explain the rally in the Yen. The more reasonable explanation was timing and positions.

The Japan market trends had been generated to a large extent by non-domestic portfolio flows. This accumulation of positions had generated good profits. The start of the summer is always a likely time for profit taking. The tapering story injected a degree of uncertainty and triggered profit taking by non-domestics. No doubt this encouraged those domestic investor that had participated in the trends to join the exodus. A correction ensued.

Domestic investors have remained collectively sceptical of Abeconomics. This is to be expected. After 20 odd years of stagnation and of successive governments pursuing fine-sounding but ineffective policies, the cynicism can become imbedded. There is also the prospect of a rise in the consumption tax, an event that has coincided with poor economic developments in the past. As has been argued in a previous blog, the impact of the consumption tax may not be what many fear but one can forgive the locals for not being convinced.

The Abeconomics project still has a number of elements to negotiate, notably tax reform. However, the local investor may soon start to act in tandem, even if sceptical. The stability of the JGB market in the face of rising rates in non-domestic bond markets is generating pressure for portfolio outflows. Such flows have considerable the capacity to weaken the Yen further and, given the evident negative correlation, strengthen the Nikkei.

Abeconomics, Yen and the Fibonacci series

A comment by the Japanese economy minister, Akira Amari, has elicited some Yen buying ( http://bloom.bg/10fAPuC). Not very much buying in the great scheme of things but it does serve to illustrate some interesting aspects of market dynamics and the very loose connection between policy and markets.

The first thing to always consider is what he actually said and not what the sound bite from the news agency implied that he said. Was something lost in translation? What was the context? Bloomberg report his comment thus:

It’s being said excessive yen gains have been corrected a lot,” Amari said on the public broadcaster NHK yesterday. “If the yen extends losses a lot, people’s lives will be negatively affected. It’s our job to minimize that.”

The yen gains have been corrected to some extent. Whether it is a ‘ a lot’ rather begs question of compared to what? If the yen weakens further some people’s lives will be affected negatively. This is true and others will be affected positively. Now here comes the interesting part; ‘It is our job to minimise that’. Does this mean to minimise further weakness in the yen or to minimise the negative affects on people of further yen weakness. The FX market naturally opted for the former interpretation and sold yen.

FX traders always remind me of sparrows. They take flight at the slightest noise but always return to the source of the bread crumbs. The result is you always get a second chance to buy or sell FX if you want to do so. The FX market is noisy but trends are usually clear and long-lasting. The trends do, however, correct just like any price trend and this should not be ignored.

First, to deal with the Amari comment, whatever he really meant is largely irrelevant. If monetary policy is to double the money supply in two years then the currency outcome is not in the hands of the policy makers. Further yen weakness is inevitable. Indeed it is implicitly desired. The purpose of the monetary expansion is to boost inflation expectations. Yen weakness will be most useful in this respect. The negative effect is the rise in bond yields that ought to result. I have dealt with this in previous blogs.

Second, it is worth asking how far the yen might weaken and what kind of correction might the path experience. For this i refer you to the above chart and the Fibonacci series. Chart analysis is anathema to economists and finance academics as it seems to contradict the efficient markets hypothesis. Whatever!

Chart analysis is widely used by traders and the Fibonacci series features prominently is this analysis. The above chart indicates the Fibonacci-derived retracement levels for dollar yen for a monthly chart. The 50% retracement was approximately 100 (it is sensitive to small variations in line drawing) and the 61.8 % retracement is approximately 105.5. The ascent of dollar yen has been swift and steep and this has pushed it into ‘overbought’ territory. Dollar yen breached important resistance at around 101.50 and has further resistance at around 108 from the declining trend of peaks.

As this is a monthly chart much depends on where we close on 31 May. The most likely pattern now however is for dollar yen to trade between 100 and 105.50 for a month or so. A close above 105.50 would suggest a good chance of a move up to the May 2007 high of around 124. A close below 100 would open up more negative possibilities.

Speak to different Chartists and they will read the runes in different ways. I am not a Chartist but do acknowledge that charts contain information. Used in conjunction with all other information they can be helpful. So what do we know? The BoJ is aiming for a very rapid doubling of the money supply. This is aggressive and quite consistent with a dollar yen move to 124. Dollar yen has moved some way quickly and may be due a pause. However, this pause could merely amount to a sideways move within a 100 to 105.50 range. Conclusion? Buy 100 and sell 105.50 until the range breaks. Simples!

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Abeconomics, deflation and the Japan conundrum

English: Japanese Prime Minister Shinzo Abe at the G8 summit in Heiligendamm. (Photo credit: Wikipedia)

Shinzo Abe was returned to power as prime minister of Japan in December 2012 on a promise of returning the nation to prosperity. A major element of the prosperity programme was to raise achieved inflation to 2%. The idea of a politician winning a landslide victory on a platform of higher inflation sounds a little odd from a ‘western’ perspective. However, anyone with even a glancing knowledge of Japan since 1989 will grasp that it makes complete sense. The enduring problem for Japan has been deflation.

Inflation and deflation are normally discussed in terms of ex post outcomes of various price indices. However, both are fundamentally ‘states of mind’. It is the expectation of inflation/deflation that does the economic work. Price index outcomes will feed back and effect these ‘states of mind’ or expectations but there is much more going on. Deflation might be defined as structurally negative inflation expectations. People fear falling prices even if actual price falls are not spectacular. It would be safe to say that Japan has been in a state of deflation, so defined, for a long time and Abe is attempting to break this destructive state of mind.

The problem for Abe is that he is beginning with a huge outstanding government debt. Suffice it to say that if Japan were to suddenly find itself a member of the eurozone, then the resulting sovereign debt crisis would end the euro project. The debt is, in part, the result of various attempts by previous administrations to stimulate the Japan economy. A fair chunk of it is owned by the Bank of Japan.

Official Japan nominal interest rates are basically zero. This has been the case for some time. The BoJ has engaged in some quantitative easing. The Ministry of Finance under various administrations has tried borrowing to fund government spending. Yet here Japan still is with structurally negative inflation expectations. Will Abe do more of the same? Why will this work? More important, what if he succeeds and yields on the outstanding and new debt suddenly shoot up because inflation is back? This conundrum seems to be exercising economists and commentators quite a bit.

The solution lies in a policy action that is deemed anathema in economic textbooks. It was discussed in relation to the UK in a very tidy article by Gavyn Davies published in the FT on October 14, 2012(http://on.ft.com/SU1ucg) and which is well worth reading. The FT were gracious enough to publish a letter from myself (December 8, 2012, http://on.ft.com/ZuuQQL) suggesting that this policy option was the only viable option left to Japan and that Japan was probably the only country in which such a policy is appropriate at the moment. The only option left for Japan is of course debt cancellation by the Bank of Japan.

The normal response from conventional economists is a shriek of horror and the mouthing of the word inflation. Well yes, i sincerely hope so! How might this work? Structurally negative inflation expectations bring a particular form of economic behaviour. People like to hold wealth in cash or near cash assets. The expected return is the negative inflation rate plus any nominal interest they might earn. Indeed if inflation expectations are structurally negative then the demand for fiat money continuously exceeds supply. This is why prices keep falling. There is a simple solution. Supply the fiat money that is demanded.

The BoJ could announce that it is to give the MoF an unlimited and indefinite overdraft. The MoF could use this overdraft to buy back as much debt as it deems necessary. It could use the overdraft to fund some or all future government expenditure. This is pure monetary financing. It is economically equivalent to debt cancellation. The fiat money supply grows by the amount of the overdraft. Bond yields are kept in check by government purchases and the knowledge that future issuance may not be forthcoming. The system gets all the fiat money is desires. The BoJ balance sheet balances. Inflation expectations go positive. Job done.

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