As we reach the one year anniversary of regime change at the Bank of Japan, market perceptions of Abenomics are shifting. After the stellar performance of 2013, Tokyo stocks have been soft this year. Meanwhile the yen has edged higher.
The immediate cause is that macro hedge funds and other short-term foreign players – dubbed “the tourists” by market participants – have taken their chips off the table. Indeed the selling of stocks by foreigners in early March was the largest for a single week since Black Monday in 1987.
Powerful moves in the stock market and the yen were the most visible signs of Abenomics at work. A partial reversal is bound to raise doubts about the project’s sustainability. Is the magic fading? If so, what next?
First it is worth noting that Prime Minister Abe has been hugely successful in political terms. His approval rating is rock-solid at 60%, which makes him the most popular leader in the G8, leaving aside Vladimir Putin. For the foreseeable future, he holds all the cards.
The reason is that economic conditions have been visibly improving. Last year nearly a million new jobs were created in Japan, the best performance since 1991. Thanks to demographics and limited immigration, the labour market has tightened to the extent that there are now more jobs on offer than applicants. Uniquely in the developed world, the pendulum is swinging from capital back to labour. Not surprisingly, Japan is the one place where inflation has been surprising on the upside, according to an indicator developed by Citigroup Global Markets.
In terms of long term structural issues, Mr. Abe’s key achievement has been little noted. In 2013, Japan’s nominal GDP grew by 2.2% year–on-year. That may not sound like much, but crucially it is above the level of long bond yields for the first time in eighteen years. Generating NGDP growth higher than the level of interest rates is the only way Japan can deleverage over time.
So far, so good. But the future, as ever, is uncertain. Turbulence in emerging markets, weak US job growth, the slowdown in China – these are all extraneous factors which have the potential to lower global bond yields, drive the yen higher and roil the Tokyo market.
Furthermore Mr. Abe faces two serious domestic challenges. The first is the growth hiatus that will likely follow the imminent hike in the consumption tax. In economic terms, squeezing household purchasing power at this early stage was a clear misjudgement. In political terms he probably felt that he needed to secure the support of the all-powerful Ministry of Finance, without which Japanese leaders rarely last long.
The second is to convince domestic institutional investors that the exit from deflation is real. So far they have not bought equities or foreign assets on any serious scale. Despite the steady rise in inflationary expectations, they are acting as if they are still in 2011, clutching onto government bonds that have substantial downside risk and little upside. As a result the Japanese stock market remain unhealthily reliant on the whims of the investment tourists.
Both problems have the same solution. Mr. Abe must ignore the nay-sayers and reinforce the reflationary message. A good start would be to restructure Japan’s Godzilla-sized Government Pension Investment Fund, replacing the current bureaucrat-dominated system by professionals with proven track records. If the tax-hike proves more damaging than expected – and the recent sharp fall in consumer confidence is worrying – the government should pledge no further tax hikes until NGDP growth has exceeded 3% for several years.
Once again, though, the crucial player will be Haruhiko Kuroda, the governor of the Bank of Japan. In US market lore, it’s always a mistake “to fight the Fed.” Mr. Kuroda must entrench the perception that it’s similarly wrong-headed “to battle the BoJ.” The way to accomplish this is through a second round of unorthodox monetary stimulus as surprising as the “shock and awe” of April 2013. Scale alone will not do the trick this time. The key will the content of the programme of asset purchases. The greater the proportion of risk assets – ETFs, REITs and real estate loans – the more potent the impact.
According to Robert Louis Stevenson, travelling hopefully is better than arriving. So it is with the investment tourists, whose restlessness means they must always be seeking out exotic new destinations. It is essential for the success of the Abenomics project that their money be replaced with the patient capital of long-term residents who know the nooks and crannies of the landscape.
