Chris Woods of CLSA is out with his famous latest weekly commentary Greed and FEAR. Last Week, Woods discussed China and expressed doubt whether China could ever rebalance from an export oriented economy to one oriented towards the consumer. This week Woods talks about Japan, and although the report came out after the huge drop in the Nikkei that is only a side point. Below is the entire report from Greed and Fear titled Greed & Fear (More Asean and less “tapering”).
Greed and FEAR
Financial markets remain obsessed with the comments emanating from central bankers. Yet from the standpoint of the Federal Reserve, Ben Bernanke has not really said anything in the latest public comments to encourage hopes of normalisation of monetary policy.
Rather the official line is that the pace of asset purchases under quanto easing can be both increased and reduced depending on the data. Meanwhile, real “tapering off” requires evidence of “sustained improvement” in a labour market where the major driver of the falling unemployment rate continues to be people leaving the workforce rather than jobs being generated.
GREED And Fear Remains Skeptical
If the above is the Fed’s official line, the ten-year US Treasury bond yield finally crawled back over 2% yesterday (see Figure 1). Still GREED and fear remains skeptical how much further this bond sell off will go given the reality that official inflation data is declining in America, most particularly Billyboy’s favorite indicator, the core PCE deflator. Thus, the core PCE deflator rose by only 1.1%YoY in March, down from 1.3%YoY in February and a recent high of 2%YoY reached in March 2012 (see Figure 2). This is also relevant from the standpoint of the foreign exchange market. The US dollar has enjoyed a renewed head of steam of late based on rising expectations of normalization of monetary policy. Thus, the US Dollar Index has risen by 3.5% since 1 May to 84.4, the highest level since July 2010 (see Figure 3).
There is absolutely no doubt that the dollar would surge dramatically higher if the Fed really ended quanto easing and resumed monetary tightening. But GREED and fear still finds this hard to imagine. Indeed the base case here remains that if expectations of normalisation of monetary tightening escalate, such a contemplated exit from unconventional monetary policy is likely to be short circuited by the resulting negative market action, most particularly in leveraged credit markets.
As for what is now the most extreme experiment in unconventional monetary policy, namely Japan, this week saw the third policy meeting held under new BoJ Governor Haruhiko Kuroda. The most interesting point here is that Kuroda in a post-policy meeting press conference played down concerns generated by recent volatility in the JGB market while also indicating that he was confident that the BOJ had the means to prevent dangerous spikes in long-term interest rates via its aggressive purchases. But Kuroda also noted that rising long-term bond yields driven by expectations of rising nominal GDP growth were acceptable.
If the ever chatty Kuroda’s confidence should be welcomed by markets, investors in Japanese equities need to keep a close eye on the JGB market since it is the potential source of systemic risk given the sheer scale of Kuroda’s proposed JGB purchases in the context of the total issuance. Remember the BoJ’s plan is to purchase more than Y7tn of JGBs per month, equivalent to about 70% of new JGB issuance, this year and next. Still for now GREED and fear will continue to recommend investors overweight Japanese equities though, as noted by CLSA’s technical analyst Laurence Balanco this week, the stock market has been overdue a period of consolidation (see CLSA research Price Action Derivatives – Global technical research, 21 May 2013). Indeed such a correction began with today’s 7.3% decline in the Nikkei 225 (see Figure 5), which will doubtless trigger some liquidation by retail investors operating on margin.
As for the yen, the sheer scale of the coming BoJ balance sheet expansion means the base case must be for further yen depreciation. CLSA’s head of economic research Eric Fishwick’s target is for Y120/US$ by the end of 2014. Still as previously discussed here, there are clear risks to the Japanese macro story posed by too rapid a depreciation of the yen. This is why it was interesting to see Japanese Economy Minister Akira Amari expressing caution at the end of last week about too rapid a yen deprecation. Thus, Amari said on Sunday that “if the yen keeps on weakening a lot more, it will have a negative impact on people’s lives” and that “it’s the government’s job to figure out how to minimize that impact”. If this logic is followed through, it would indicate that Japan would be willing to intervene if the yen weakens too rapidly. Still Amari appeared to qualify, if not retract, these comments this week resulting in a certain confusion.
Any such currency intervention policy might be resisted by the ultra-aggressive Kuroda since the most likely way he is going to meet his inflation target of 2% in two years is via a surge in imported energy inflation. Meanwhile, the latest trade data showed the tenth consecutive month of trade deficit primarily caused by energy imports. Thus, Japanese exports rose by 3.8%YoY in April while imports rose by 9.4%YoY, resulting in a trade deficit of Y880bn. Within this aggregate, imports of mineral fuels increased by 3.6%YoY to Y2.33tn in April while the trade balance excluding mineral fuel imports remains in a surplus of Y1.45tn (see Figure 7).
This is why a critical issue for the yen in the medium term remains whether Prime Minister Shinzo Abe turns back on nuclear power plants in line with stated LDP policy. A brief trip to Kuala Lumpur this week inclines GREED and fear to stick with the current double overweight in Malaysia in the Asia
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