Things are suddenly getting interesting in Japan and at the BOJ with markets solidifying for a August hike on the one side and somewhat deteriorating economic fundamentals on the other. Yesterday, the BOJ chose to hold rates steady with a vote of 8 to 1 but by taking a quick sweep across market indicators they all indicate that an August hike is in the bag or at least in September where swap contracts on the overnight call rate indicate a 96% probability of a hike; in August the corresponding probability is 73%. Yet, you cannot but wonder that feelings are getting increasingly more itchy across trading desks as regards to the timing of the next BOJ move and whether in fact it will come in 2007 at all? This then brings us into my statement above concerning 'somewhat' deteorating economic fundamentals a topic which I also elaborated in my last note on Japan.
Let us however begin with the good news represented by the latest data on Japan's external balance which showed that the current account surplus widened to an all time high in May 2007. The big story here is however not so much the trade surplus which indeed is thundering along just fine with a 1% increase but rather the income surplus which also posted a healthy gain. It is of course difficult to say to which degree Mr. and Ms. Watanabe are responsible but in a more general perspective it is amazing to see the sea change in Japan where domestic investors traditionally exhibited notable home bias something which is undoubtedly contributing to the recent impressive growth in the income surplus. This small snippet from Bloomberg is very much to the point ...
The income surplus exceeded the trade surplus for a fifth month in May, the Finance Ministry said. The difference between money earned abroad and payments made to foreign investors in Japanese companies surged 36.6 percent to 1.79 trillion yen, the second highest on record.
Returning to the domestic economy we don't yet have real data from June which makes my previous note on the May data pretty much up to date, at least when it comes to inflation and domestic consumtion data. However, we do have some confidence indicators which do not exactly make August's BOJ any easier to the extent that we were pretty certain that a hike would be on the menu. Firstly, we have the confidence measure for merchants which fell in June and secondly we saw, rather worryingly, that consumer sentiment also dropped. However, as a last data point we also recently saw that machinery orders rose briskly in May which perhaps suggests that corporate capex is ready to nudge back up over the summer although as Edward notes in this post and accompanying graph, corporate capex/industrial production is still on a high level in relative terms.
As per usual we have a bit of good and and a bit of bad news from Japan this time around. Coupled with yesterday's decision to hold rates steady markets still seem convinced that August will see the BOJ move to 0.75%. Everyone seems more or less certain on this and even the always duly skeptical (and excellent) Takehiro Sato from MS' GEF also recently noted that the BOJ could raise in August although whether they actually should is of course another question. Regarding my own call I feel a bit of deja vu pointing back to February where markets were snubbed by the BOJ in what was also, at the time, an almost sure move. And in thread with Edward I really do not hope for MS that they have to apologize again come August. No tongue in cheek should be detected here, Japanese economic conditions and monetary policy are not at all easy, at this point, to forecast and this is especially the case when it comes to the BOJ's rate decisions. In line with my recent explicit call for a hike to 0.75% I am sincerely wobbling at the moment; especially, given the recent signs that the modest yet, by Japanese standards, impressive spurt in domestic demand is coming to an end in Q3 and Q4 2007. As such, and dare I say it, I am moving back into hold territory for August with the important qualifier that domestic demand and inflation figures for June could swing me back in line with the consensus if they exceded expectations which in this case would represent a mild improvement over May. Before I leave, I should also note the increasing uncertainty surrounding the general rate policy discourse at the BOJ where both Fukui and other prominent members of the committee have noted how the current gradualism might give way to a willingness to raise even as inflation remains subdued. This would then point to a more forward looking course with an explicit assumption of inflation pressures building in 2008. However, this is also the whole issue here at this point and August will be a test to whether this discourse will also translate into action, I have my doubts but the outlook is clouded indeed.