Japan: Land Of The 'Lost Decade'

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Includes: DBJP, DFJ, DXJ, EWJ, FXY, JOF
by: Interactive Brokers
Summary

Investors surveilling Japan’s economic landscape are set to receive updates on the country’s inflation rate and manufacturing sector, amid fears of further slowing and deterioration.

Japan has been grappling with stubbornly low levels of inflation for almost three decades, following the collapse of its economy in the early 1990s.

Meanwhile, the country's central bank’s ongoing stimulus measures have been yielding little impact on prices.

Asia-Pacific: The Week Ahead (Mar 18-22)

Investors surveilling Japan’s economic landscape are set to receive updates on the country’s inflation rate and manufacturing sector, amid fears of further slowing and deterioration.

Japan has been grappling with stubbornly low levels of inflation for almost three decades after the collapse of its economy in the early 1990s, while its central bank’s ongoing stimulus measures have been yielding little impact on prices.

At the release of its January monetary policy report, the Bank of Japan elected to maintain its negative interest rate of -0.1%, as well as its purchases of Japanese government bonds (JGBs), exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs).

The bank said it will also continue with its ‘Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control,’ which it expects to continue “as long as it is necessary” for reaching and maintaining its 2% inflation target.

QQE was initially rolled-out in April 2013.

Furthermore, the BoJ is committed to expanding the monetary base until the year-on-year rate of increase in the consumer price index (CPI, ex-food costs) exceeds 2%. However, to date, this target seems far afield, as the bank’s ongoing efforts to strengthen its policy framework has had little effect on the inflation rate.

The nation’s CPI rose 0.2% year-on-year in January 2019 and was up 0.3% from the previous month.

The World’s Highest Debt-to-GDP

Fitch Ratings analysts Stephen Schwartz and Thomas Rookmaaker recently noted that Japan's gross general government debt (GGGD) of around 230% of GDP is the highest among the sovereigns the ratings agency covers.

However, Fitch said the country appears to have been making some progress on this front, given faster nominal GDP growth, which has been helping to keep its public debt in check. Japan’s economy, the ratings agency continued, has been expanding since the end of 2012, making it “one of the longest such periods on record.

“Moreover, exceptionally tight labor market conditions have led to a modest pick-up in nominal wage growth, helping to pull the economy out of a deflationary spiral.”

Furthermore, the rise in tax revenue due to the consumption tax hike from 5% to 8% in 2014 may amount to around ¥8tn, or 1.5% of GDP.

Yutaka Harada, a member of the BoJ’s policy board, recently highlighted at a meeting with business leaders that while Japan's fiscal situation is “severe,” its deficit in fiscal 2017 shrank to 2.7% of GDP – an improvement of 5.5% over the deficit incurred in fiscal 2012. He attributed the decline to Japan’s overall economic well-being, as well as the uptick in government tax revenues.

Harada also indicated that a reduction in mobile phone-related prices should help spur inflation, however “a precise figure cannot be given as to how large its impact will be.”

Overall, the market’s perception of Japan’s ability to honor its debt obligations has been mostly positive. To date, spreads on its sovereign five-year credit default swaps (CDS) have narrowed by almost 6bps over the past three months to roughly 21.4bps.

'Japanification'

Against this backdrop, market participants generally refer to economies that can endure a prolonged period of low-growth expansion, accompanied by low levels of inflation, as “Japanification.”

Analysts at Benzinga pointed out that prior to 1991, “Japan’s economy was booming,” but when an asset bubble burst in that year, its economic “production plummeted.”

Benzinga recalls the period from around 1991 to about 2001 as Japan’s ‘Lost Decade,’ which was underscored by near-zero interest rates and negative economic growth. From 1995 to 2007, Japan’s GDP fell from US$5.3tn to US$4.3tn, and wages fell roughly 5%. At the same time, Japan’s government ran at a “massive” deficit to help stimulate the economy.

As a result, Benzinga added Japan’s debt-to-GDP ratio mushroomed to a higher level than any other country in the world by a wide margin. Compared with Japan’s more than 230% debt-to-GDP ratio, the U.S.’s is around 103%.

Calendar of Events

Economic releases in the week ahead will kick off in earnest with:

Tuesday, March 19

  • Reuters Tankan Index (Mar)
  • Bank of Japan To Release Monetary Policy Meeting Minutes

Wednesday, March 20

  • Leading Economic Index (LEI) – Jan (NYSE:F)
  • Coincident Index (Jan – f)

And investors in the latter part of the week will receive:

Thursday, March 21

  • CPI (Feb)
  • Nikkei Manufacturing PMI (Mar – Flash)

IHS Markit is set to unveil Thursday a flash reading of its Nikkei Manufacturing Purchasing Managers’ Index (PMI) for March after the prior month registered the first contraction in the sector since August 2016.

The headline figure fell to 48.9 from 50.3 in January – the lowest in 32 months.

The deterioration primarily resulted from a sharper downturn in Japanese goods producers’ output in February, while new order intakes fell at an accelerated rate.

IHS Markit economist Joe Hayes warned that global “trade frictions and weak domestic manufacturing demand pose considerable risks to Japan’s goods producers.

“As such, firms pared back expectations to near-neutrality.”

Hayes added that with the 2% consumption tax hike to 10% set to come into play in October 2019, “weak domestic demand will only heighten fears that the economy could be poised for a downturn.”

Market participants will be keeping an eye on Japan’s manufacturing sector, as well as its CPI, for any further signs of that potential downturn.

Note: This material was originally published on IBKR Traders' Insight on March 12, 2019.

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