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Over the course of the six months from November 2012 to May 2013 the Nikkei gained a staggering 85%. However, it is also interesting to note that the top price in all the global indices during this time coincided with Ben Bernanke’s quantitative easing (QE) taper hints – it was not just the Nikkei that had a softer Q3.
Inflation targets are being met
The three arrows that make up the economic recovery plan christened ‘Abenomics’ – massive fiscal stimulus, more aggressive monetary policy easing (both implemented) and structural reforms (still to come) – have gone some way to achieving the aims of the nation; the key one being an inflation target of 2%.
Japan’s long-term interest rate, i.e. the yield on long-term government bonds (corrected for inflation), has become negative and has thus encouraged investors to seek profit elsewhere. The Nikkei has seen a degree of this capital flow.
Next year the Japanese government plans to increase the sales tax for the first time in 15 years. The country’s fiscal imbalances are being addressed this way – it has the highest gross debt to GDP in the developed world. Given that Mr Abe is trying to offset the effects of this with a five trillion yen stimulus package (details as yet unknown), if the markets support his move we could expect to see a greater degree of confidence coming both domestically and globally, which should add up to a stronger Nikkei. Conversely, if the market do not get behind it, Mr Abe has the option of increasing said stimulus and possibly expanding the current QE programme.
All in all, the odds appear to be stacked in Japan’s favour. Examination of forward-looking indicators like machinery orders in August also gives the markets cheer, and helps to reinforce the perceived success of Abenomics. An increase of 5.4% month-on-month in August against an expected rise of 2% indicates that a durable and sustainable recovery cannot be discounted.
August saw an acceleration of the core consumer price index to 0.8%; add to that a six-year high in the quarterly Tankan survey, and you can see a clear indication that medium and large firms are getting behind the Abenomics effort.
What has or could upset the trajectory?
The simple answer to this question is: the US Federal Reserve.
Now that tapering is probably off the table until Janet Yellen is ratified and ensconced as Fed chair, it will be interesting to note the reaction in global equity markets. The reason we haven’t seen a massive sell-off yet is been because the punch bowl is still on the table.
Clearly the shenanigans in Washington have not helped with a weakening yen, but one would expect that if and when we do see a resolution the dollar should perform something resembling a rally, and this can only be kind to the yen. Breaking through the 99.85 level would put the bias to protracted dollar strength, and any inkling of a tapering of QE in early 2014 should also be a benefit.