Japan's Outlook: Rising Sun or Rising Rates?

Allowing U.S. banks to keep bad assets on their books has resulted in a continued unwillingness to lend and generated a host of comparisons to Japan’s economy in the 90s which has been dubbed “The Lost Decade”.

The question now is not whether it was a lost decade but whether that decade is part of a lost generation. With their CPI falling 4.3% since 1989, deflation seems well entrenched in the Land of the Rising Sun. YoY numbers for September showed a 2.3% decrease which was the seventh straight drop. Additionally, the Bank of Japan forecast a 1.5% drop in its core consumer price index which excludes fresh food prices for the year ending March 31, saying that it expects a 0.8% drop in the measure in the next fiscal year and a 0.4% fall in the following fiscal year.

A culture long known for brand-obsession seems to be downsizing its appetite for luxury as consumers there are trading down from Versace and Louis Vuitton to H&M and Forever 21. “Luxury is not in vogue right now given the lack of consumer confidence,” said Larry Meyer, Forever 21’s CFO. “The values of Japanese consumers are changing – people used to be concerned that cheap clothes meant poor quality, but not anymore,” is how Hidehiko Aoki, retail analyst at Bank of American Merrill Lynch in Tokyo described the change.

With its debt to GDP ratio already expected to hit 227% in 2010 according to the IMF, Japan’s aging population will deliver the double blows of requiring higher levels of social security while delivering lower tax receipts. Masaaki Kanno, an economist with J.P. Morgan Chase, thinks the debt to GDP ratio could rise to 300% in the next decade. Additionally, Fitch Ratings warned recently that projected issuance of Y44TN ($489BN) in 2010 without a “credible plan” to rein in public finances could pressure ratings on the country’s sovereign debt which were initially cut from “AAA” in 2000 and now sit at AA-. The CDS market is becoming wary of the situation in Japan as the cost of insuring the nation’s sovereign debt has doubled over the past three months to 75bps.

BOJ Governor Masaaki Shirakawa is aware of the need to tread softly as his country and the world emerge from one of the worst financial crises in recent history. While announcing that some of the little-used measures put in place at the height of the crunch to facilitate corporate funding would be removed, he was careful to reassure the markets by saying, “It is expected to take time until the Japanese economy returns to a full-fledge recovery path. We will maintain very accommodative financial conditions and keep supporting the economy.”

If there are bright spots, one would be the slight upward revision in the GDP forecast by the BOJ which was raised from a drop of 3.4% to a drop of 3.2% for the current fiscal year. Also, the nation’s penchant for saving has allowed rates on the government’s debt to remain low with the yield on the 10-year note just under 1.5% - albeit 25bps higher than a month ago, but they are still quite low on a nominal basis. These low rates put interest payments at about 10.3% of general government revenue which is comparable to other highly rated sovereigns with much lower total debt levels according to Fitch Ratings.

Rising sun or rising rates? It would appear the decisions Japan makes now are critical in determining which comes to pass.

Enjoy the week.

Comments

[Moon Kil Woong:]

Undoubedly the governments QE, 0% rate policy, and massive stimulus prolonged Japan's downturn (perhaps at the cost of blunting it). Now that the US is doing the same will we get the same results. Probably not.

Japan can finance almot all of its debt domestically where we can't. That probably means we will be forced to raise rates like Japan is confronting just now whether or not we are still in a economic rut.

Nov 16 10:57 AM

[Dave Wrixon:]

Since when could you really substantiate the "Added Value in Louis Vitton or Versace"? When the tide goes out, you can see where the rocks are.

First Norway, then Australia and now Japan. It is not them you need to cry for. Rising rates elsewhere will finally precipitate the looming dollar crisis. If you have been crying over the depreciation to date, you have seen nothing yet. Of course any increase in rates will make the US Government insolvent and throw the economy into a deep depression, which may weaken confidence and further erode the dollar setting of a vicious cycle as other central banks start scratching and gouging to get to the exit.

Nov 16 11:37 AM

[Mad Hedge F...:]

xgi As much as I want to find a trade in Japan and therefore have an excuse to go there again, my searches have recently come up empty. With America maintaining its lead in innovation and the creation of new business models, and China taking over the world’s low end manufacturing, it is hard to see a future for Japan. Can a country of 127 million live only off of the high end manufacturing of luxury cars, video games, and electronics? The country is increasingly looking like a “has been” emerging market. During my career, I watched GDP growth rates fall from a white hot 10% in the sixties, to 4% in the seventies and eighties, to 1% in the nineties and the early 21st century. Are we flat lining at 0% in the teens? That leaves fertile ground only for stock pickers who are willing to do the local spade work to find one hit wonders like Toyota and Fast Retail. That is a job best left to country specialists, like my old friend, 40 year veteran Ed Merner, who runs the Atlantis Japan Growth Fund (LSE-AJG) traded in London, which has shot up a sizzling 80% in six months.

Nov 16 11:56 AM