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Friday, November 30, 2007

Japan Building Construction Starts November 2007

Japan's housing starts fell for a fourth month in October as stricter rules for obtaining building permits and the impact of the US sub-prime credit tightening continue to place a burden on economic growth. Starts tumbled 35 percent in November from a year earlier after falling 44 percent in September, the Ministry of Land Infrastructure and Transport said in Tokyo today.



The government eased regulations earlier this month in an attempt to prevent the slump from derailing growth after housing investment became the main drag on the economy in the third quarter. Loan relief to small companies hurt by the new rules will also be provided, the government said, after bankruptcies in the construction sector swelled by a fifth last month.

http://www.bloomberg.com/apps/news?pid=20601101&sid=aJ_nAS3VHcec&refer=japan

On an annualized basis, housing starts rose to 850,788 units from September's four-decade low, the report showed. It was the first increase in four months.

Japan altered the building code on June 20 after an architect fabricated earthquake-resistance data in 2005. Builders complained that the new system was introduced too fast, they didn't have time to adapt to the requirements and it was difficult to get approvals for any changes to plans.

Government officials and some economists are saying that the worst may now be over for the industry. The building-approval rate doubled to 50 percent in October from a month earlier, Land Minister Tetsuzo Fuyushiba said this week, and the approval rate for submissions through Nov. 23 rose to 71 percent, the ministry have said.

Still, all this needs monitoring carefully, since the decline in housing investment has already shaved a significant amount from Japan's 2.6 percent annual expansion rate achieved in Q3.

Japan Retail Prices, Employment, Income and Consumption October 2007

Japan's economy showed its first signs of inflation this year after food and energy prices both rose in October. Core consumer prices, which exclude fresh food, climbed 0.1 percent in October from a year earlier, the first increase since December 2006, the statistics bureau said today in Tokyo, while the index excluding food and energy continued to fall (by 0,3%).



Claus - who is busy with exams at the moment - normally covers this area here, so I will simply say that I doubt very much that this small rise will be enough to have any significant impact on Bank of Japan thinking about interest rates as the U.S. economic slowdown and financial-market turmoil cloud the outlook for growth, and the employment and earnings outlook in Japan continue to remain weak. I fuller examination of Japan's recent inflation dynamics can be found in this post from Claus examining the September data in detail.

Turning now to employment, the headline data is that the unemployment rate stayed at 4 percent in October after rising in each of the two previous months.



The rate has risen from a nine-year low of 3.6 percent in July. The number of jobs available for each applicant had the steepest decline in six years. Also worthy of note is the fact that the total number of employed persons in October 2007 was 64.24 million, a decrease of 130 thousand or 0.2% from the October 2006. As we can see in the chart the total number of those employed has been declining steadily since the peak in May. More detailed analysis of the current labour market dynamics will have to await the publication next week of October's edition of the Monthly Labour Survey.




For two-or-more-person households, the statistics office have also announced that the annual rate of increase in household spending slowed in October to 0.6 percent from 3.2 percent in September.



For workers households, average monthly income per household stood at 469,981 yen, up 0.6% in nominal terms and up 0.4% in real terms from the previous year.

Thursday, November 29, 2007

Japan Industrial Output October 2007

Well, industrial output in Japan seems to be performing well at the moment since Japan's industrial production rose to a record in October. Output rose a seasonally adjusted 1.6 percent from a month earlier, when it fell 1.4 percent, the Trade Ministry said in Tokyo today. The year on year rise was 3.5 percent.



Clearly this would seem to indicate that exports continue to hold up well, although there are also the comparatively strong October retail sales (reported yesterday) to take into account, since they mean that domestic demand, despite the weak earnings numbers, is not entirely flat.

Wednesday, November 28, 2007

Japan Retail Sales October 2007, the Employment Outlook and the Topix Bear Market

Japan's retail sales rose at the fastest pace in more than a year in October as consumers bought new-model cars and record gas prices increased revenue at filling stations. Sales climbed 0.8 percent in October from a year earlier, and this constituted the third monthly gain, according to the Ministry of Economy, Trade and Industry in Tokyo this morning. Well, that's the headline news, and here's a slightly longer term chart.



As we can readily see, there is nothing especially impressive about Japan's recent retail performance, and only in Japan would it be headline news that sales had managed to eke out a 0.8% y-o-y increase (sales rose by only 0.3% in 2004, by 1.2% in 2005, and actually fell by 0.2% in 2006 - the highpoint of the latest expansion - a little detail which helps put some of the recent y-o-y increases in perspective, since in many cases we are only recovering 2005 levels). So I think we need at the very least to be rather cautious here about the extent to which this "surge" in consumption is going to do much to offset the sharp reduction in Japanese housing starts, and declining export sales to the United States. Add to this the looming fiscal tightening reported on earlier in the week and it is hard to see on which of its various weakening legs the Japanese economy is now going to stand (interestingly enough the cabinet office publication referred to below states that the "Acceleration and deepening of reforms will hereafter be pursued based on the 'Economic and Fiscal Reform 2007'" which means watch out for either a consumer tax or a reduction in public spending as the next key arm in the reform process).

In fact, and in far more realistic vein, the Japanese government this week cut its assessment of the job market for the first time in more than three years, calling into question in the process one of the central bank's key arguments for raising interest rates. "Job-market conditions continue to be difficult and there has been a pause in improvement" the Cabinet Office said in its monthly economic report for November, following a rise in the unemployment rate for two consecutive months. The unemployment rate climbed to 4 percent in September, up from the 3.6 percent registered two months earlier. The total number of employees fell 0.7 percent in September, while the number of workers at companies with five or more people increased 0.3 percent.

On top of this wages, far from rising earlier in the year as the labour market tightened, have declined in nine of the last 10 reported months and mid-year bonuses, which constitute about 10 percent of a worker's annual income, dropped this summer for the first time in three years.

However, such "minor adversity" notwithstanding, the Japanese government does still feel bold enough to keep to its overall view that the economy, now in its 70th month of expansion, is in the process recovering.

The Cabinet Office also reiterated its view that the "market turmoil" caused by the U.S. housing recession, yen appreciation and higher oil prices are risks to growth. Crude oil rose above $99 a barrel for the first time last week and has gained 59 percent this year. Concern about possible sudden upward movements in the yen-dollar cross continues to be widespread. The Financial Times this morning quotes the following view, which must be reasonably representative of sentiment in Japan:


Masaaki Kanno, chief economist at JPMorgan in Tokyo, said a strengthening yen clouded the picture. If the yen broke through Y100 or Y90 to the dollar, he said, it could "be a big blow to the economy" and once more raise the spectre of deflation. "In the past we didn't worry so much about yen strength as we believed the global economy would grow steadily," he said. "But if the strong yen is caused by the slowing of the global economy together with the spread of risk aversion, then probably we should be a bit more worried than before."
Claus has a fuller discussion of the issues which might be raised by any possible Japanese intervention to restrain the yen's rise on Japan Economy Watch (here).

But it is not only the Japanese government which has been pulling back its expectations, the Bank of Japan, in the shape of Bank Governor Toshihiko Fukui has also been expressing his strong concern about the ongoing turbulence in world markets, comparing it with “a serious disease”. Fukui is quoted as saying that the volatile movements in financial markets since July suggested global markets were paying the price for “euphoria and excessive risk-taking”. It was the central bank’s job, he said, “to help markets adjust themselves in an orderly manner as far as possible, while keeping markets functioning at all times.” Up to now, and despite the fact that the bank has fractionally pared-back its growth and inflation predictions for 2007, it has by-and-large stuck to its central thesis that Japan’s economy remains in a virtuous cycle. But with every passing day this view becomes more difficult to sustain, and market participants are growing more pessimistic by the day about the likelihood of any further interest rate increases from the BoJ in the foreseeable future.

Meanwhile Japanese shares have been falling . The Nikkei slid 69.07, or 0.5 percent today, falling to 15,153.78 at the close of trading in Tokyo. The move down was led by the Sumitomo Mitsui Financial Group Inc., after Wells Fargo announced a $1.4 billion pretax charge tied to increased losses on home equity loans. Shares also declined after the announcement yesterday that U.S. consumer confidence fell more than expected in November and housing prices dropped the most since at least 1988, pointing to weaker demand in what is still Japan's biggest overseas market.

Japan in fact recently had the honour of becoming the first of the world's 10 biggest stock markets to enter a bear market since the U.S. subprime-mortgage collapse, since the Topix index last week registered a cumulative 21 percent decline from its 2007 peak. The 39-year-old Topix, which constitutes the broadest gauge of Japanese equity prices fell 0.1 percent on Nov 22 to 1,437.38, in so doing reaching its lowest level since October 2005, and this was 21% down from this year's highest close of 1,816.97 achieved on Feb. 26. The Topix benchmark has in fact fallen 14 percent since 1 January 2007.

Uncertainty and volatility abound everywhere at the moment, and today we have also learned that China has now followed Japan into bear territory, since the CSI 300 Index (which tracks 300 yuan-denominated stocks) fell for the third consecutive day losing 62.40, or 1.3 percent, and closing at 4,648.75, its lowest value since Aug. 17. Todays value also represents a decline of 21 percent since from the record high registered on Oct. 16. A 20 percent drop within 12 months is widely interpreted as signaling entry into a bear market, although what quite represents what these days is in fact anyone's guess. Still, this is a very, very rapid turn around indeed, and things now need watching very carefully.

Now, as is generally known, bonds typically move in the opposite direction to stocks, and the present juncture is no exception to this little rule, since yields on Japan 10-year government bonds have been showing a correlation of 0.96 with the Nikkei this month, according to data compiled by Bloomberg. And a value of 1 would mean the two moved in complete lockstep.

So true to form Japanese government bonds rose again yesterday as investors continue to be nervous about the possibility of a quick resolution to global credit problems (and the announcement yesterday from the ECB that they are about to inject a further €30bn ($44.3bn) in one-week funds into the banking sector will hardly be making them less nervous). The rise in JGBs followed a sharp decline on Tuesday which accompanied the release of the news that Abu Dhabi Investment Authority, currently the world's biggest sovereign wealth fund, was planning to inject $7.5 billion into Citigroup Inc. Citigroup has been one of the banks which has been hardest hit by subprime mortgage sector problems and the consequent credit crunch. What is most striking about all of this is the volatility we can see everywhere at the moment.

JGB futures have recently risen to their highest since January 2006 - and yesterday ended the session up 0.21 at 137.10, close to last weeks 22-month high of 137.53 - as the global financial market problems and the steady trickle of negative news from Japan have sustained doubts over whether the BOJ will lift interest rates to 0.75 percent from the current 0.5 percent before the end of Japan's fiscal year in March. The 10-year yield fell 1 basis point to 1.480 percent, but this was still significantly above the 26-month low of 1.395 percent reached last week.

The five-year yield also fell back 2 base points to 1.025 percent, following a temporary recovery from last weeks slide to a 0.995 percent 21-month low. The two-year yield is performing in similar fashion, edging down 0.5 base points to 0.755 percent, following the nine-month low of 0.715 percent registered earlier in the month.

Conclusions?

So what conclusion (if we are bold enough to draw any in these difficult circumstances) can we draw from all of this? Well the main impressions I would be taking away are:

1/ the obvious enduring weakness in the Japanese economy

2/ the very high levels of volatility and uncertainty which exist out there at the present time, following the financial problems of mid-August

3/ that it is extremely unlikely we will see any further interest rate increases from the BoJ in the short term, and that the next move when it does come is just as likely to be down as it is up.

A fuller examination of the overall macro-economic situation in Japan can be found in Claus's recent post - Where Is Japan Heading?

Monday, November 26, 2007

Ageing and Japan's Fiscal Position

According to an article in the Japan Times (based on data from Japan's Internal Affairs and Communications Ministry) the over 75s now constitute 10 percent of the Japanese population. This figure was 1.3 percent in 1950, when the government first started tracking such data, and rose to 5 percent in 1991 before breaking the 10 percent mark this year.

As of Nov. 1, Japan's population is estimated at 127.79 million, with 12.76 million of these — 4.79 million men and 7.97 million women — aged 75 or older. The ministry compiled the estimates on the basis of the 2005 census and data on births and deaths in subsequent years.

Men aged 75 or older account for 7.7 percent of the male population, while their female counterparts account for 12.2 percent of all of Japan's women. Those aged 65 or older totaled 27.53 million, accounting for 21.5 percent of the population.

Those aged 14 or younger, meanwhile, totaled 17.28 million, down 140,000 from a year ago and making up 13.5 percent of the population. The ratio was 35.4 percent in 1950.

The latest figures show that the graying of Japan's population is progressing faster than earlier predicted. Based on the 2000 census, the National Institute of Population and Social Security Research had forecast that the 75-or-older age group would account for 9.7 percent of the population in 2007, and that those 14 and younger would account for 13.7 percent.

Given this it is very timely that Japan's top economic council - the Council on Economic and Fiscal Policy - is about to stress that the government needs to press on with fiscal consolidation efforts in light of the shrinking and ageing of the population, at least this is the gist of a press release from the Japan Cabinet Office today. (See this Reuters report).


The council is planning to call on the government to maintain its plans to curb rises in social security payouts and cut public works spending by 3 percent. According to a draft of the annual policy paper released by Cabinet Office today:

"The state of the country's public finances is extremely severe and it is apparent that future generations will be forced to bear a bigger burden as the population further shrinks and ages,"


The draft also states that the government should strive for "fundamental reforms in the tax system, including the consumption tax" to secure a stable source of revenue to cover growing costs of social security and the falling birthrate. Amongst other issues the government needs fresh revenue sources to finance a planned increase in its share of pension contributions which go up from the current 37 percent to 50 percent by fiscal 2009/10. Many analysts have said a rise in the sales tax would be the most likely scenario. But this is likely to be the subject of heated debate given the ongoing weakness of Japanese domestic consumption and key ruling party officials, including Prime Minister Yasuo Fukuda, have recently suggested the government would not raise the consumption tax next year. In principle the Japanese government is commited to achieving a balanced budget, excluding debt issuing and servicing, by fiscal 2011/12 through both spending cuts and increases in revenues, but this is a very unrealistic scenario to accept in the present political climate I feel.

Further details on and a fuller analysis of Japan's whole fiscal situation can be found in this post.

Moving Money Into Emerging Asia

Two minor pieces of news caught my eye over the weekend. In the first place Bloomberg draws our attention to a Goldman Sachs report about hedge funds shifting Asian investments out of Japan (because of lower returns and poor corporate governance) to other areas of emerging Asia.

Japan's average return on equity will be about 10.2 percent this fiscal year, compared with 20 percent in the U.S. and 15.7 percent in Asia, according to Matsui. Return on equity is a measure of how well a company uses its cash to generate profit.

Meanwhile, Japanese companies are fending off purchases by foreign firms seeking to boost share prices, by buying stakes in each other or taking so-called poison pill measures. Some 400 Japanese companies, or 10 percent of all publicly traded firms, have taken steps to ward off hostile takeovers, according to a Nikkei newspaper survey published in October.


Hedge funds investing in Japan have seen outflows of about $7 billion, while Asia ex-Japan has seen inflows of about $17 billion through October this year, according to data provided by Eurekahedge, a Singapore-based hedge-fund research company.

On another front the New York Times reported on a growing trend in Japan among individual investors for reallocating funds they have invested in the U.S. to faster growing emerging markets. Japanese investors, it seems, have reduced holdings of domestic mutual funds investing in the U.S. in 16 of the past 17 months.

In fact investment inflows in overseas-oriented funds have consistently grown at a higher clip than the outflow from U.S. funds. An estimated half of Japan's $14 trillion in personal savings is believed to be invested overseas in search of higher returns, especially in terms of yield, given Japan's extraordinarily low returns on deposits and bonds. At the same time, Japanese investors are gradually beginning to diversify their holdings, after having only embraced mutual fund investing about a decade ago. According to data from Daiwa Fund Consulting, Japanese investors have invested the dollar equivalent of $17.5B into emerging market funds over the past year, while reducing holdings of North American funds by $4B. Fund management companies have taken notice, resulting in a 36% increase in the number of emerging market mutual funds to 183 in total (vs. 137 U.S.-focused funds).

Conclusion: hedge funds are reducing their involvement in Japan, and Japanese investors are reducing their exposure to the US, and they are both headed for emerging markets, and in particular emerging Asia and Latin American where a favourable combination of both assett price apppreciation, higher interest rates and currency appreciation appear to offer a much better longer term return. Morgan Stanley's Stephen Jen got near to the core of the issue last Friday when he pointed out that:

"If one had invested US$100 in 1985, the investment would be now worth US$739 for global real estate, US$639 for equities, US$403 for global bonds, US$264 for non-energy commodities and only US$182 for crude oil (including the recent surge in oil prices toward US$100 a barrel)."

So where in the world are equity and real estate values about to get (in dollar terms) the big ride up? I don't think the answer to this question is too taxing, even your average garden-variety hedge fund manager has the capacity to see this. The real question is how fast will it all happen, and has the dollar past an interim "point-of-no-return", or are we about to see a temporary dollar resurgence? Very hard to call this one, I think.

Afterthought: there does seem to be news to suit all tastes and appetites though, since Bloomberg also report that the rumourology has it that the Chinese government - via China Investment Corp. - is considering investing money in Japanese real estate. I would have thought the interests of their citizens would be better served by putting the money in Indian, Turkish or Brazilian real estate, but then, as they say, there are opinions around at the moment to cater for all tastes.

You can find a better explanation of the logic which I think is driving all of this in this post here.

Wednesday, November 21, 2007

Japanese Exports and Global Recoupling

Claus drew my attention this morning to this interesting piece from Nouriel Roubini about global recoupling. Actually this post raises a number of points, all of them interesting ones, and some not as semantic as they seem at first sight.

But before we get into all of this lets take a quick look at the latest set of trade figures from Japan. As Bloomberg tell us:

Japan's exports rose to a record in October as companies shipped more cars and electronics to Asia and Europe, easing concern that a slowdown in the U.S. will cool the economy's expansion.

Exports climbed 13.9 percent from a year earlier, the Finance Ministry said in Tokyo today, double September's pace. That helped lift the trade surplus 66.1 percent to 1.02 trillion yen ($9.3 billion) as imports gained 8.6 percent.

Shipments to China and the European Union surged to the highest ever, cushioning a drop in exports to the U.S., where the worst housing recession since 1991 is crimping demand. Toyota Motor Corp.'s profit rose 11 percent last quarter, helped by sales of Camry sedans in Europe and Asia.


So this is, if you will, the headline grabbing story. Record Japanese exports, with a shift in emphasis away from the US and towards Europe and China. (You can find the details in this PDF here).


Now as we can see from the chart, Japanese exports have done very well indeed in value terms since the start of 2006, and have even held up very well in recent months:



If we look at the year on year chart for 2007, we will note a very strong rate of increase, and in particular how Octobers pace has bounced back from the slowdown noted in September:



But it is when we come to the actual export shares that things get really interesting, since we find that exports to the US actually declined year on year, while those to China and the EU have continued to accelerate (as they say, to some extent exchange rates matter) and indeed Japan is close to closing the trade deficit it has been running with China.




And this perhaps explains why a Japan analyst like Morgan Stanley's Takehiro Sato have been talking about "decoupling" in the Japan context, not because Japan's economy is being driven finally by internal demand (far from it), but because the direction of exports is changing, and in particular Japan is now much more sentsitive to growth in Europe and some emerging economies (Asean, China) than it is to upas and downs in the US.

On the semantics two sets of bipolar expressions seem to be going the rounds at the moment, "recoupling-decoupling" and the "hard landing-soft landing" tandem. This is not the time or the place to enter into what it is we might mean by "hard landing" (other than to say that I do not consider that a mere recession constitutes a hard landing, but it is worth thinking about what we mean when we talk about "decoupling-recoupling".

Basically there seem to be two versions of the "decoupling" thesis knocking about. The first of these (which is no very definitely going out of fashion very fast) was based on the idea that the global economy was finally decoupling from the US due to the fact that key global engines like Germany and Japan where (following in both cases lengthy periods of structural reforms) finally coming out of a long period of sub-par growth and achieving "home grown", domestic demand driven, sustainable recoveries in a way which would enable them to take more of the strain during what was perceived as being an inevitable US "correction".

Claus and I never actually bought this story, in particular since we never thought that domestic demand would recover in countries like Germany, Japan and Italy in the way in which many were expecting, essentially for age-related demographic reasons. I think history has, more or less, borne us out on that one.

But there is another sense of "decoupling" (which is the one Claus and I prefer to call "recoupling", although this is not recoupling in the way in which Nouriel Roubini uses the expression, which seems to refer to a renewed coupling to a US economy which is on the way down) and this is to do with the way in which certain emerging market economies (the EU 10, Ukraine, Russia, China, India, Turkey, Brazil, Argentina, Chile etc) are now accounting for a very substantial proportion of global growth (Claus and I have yet to do the detailed numbers on this, but suffice it to say that India, China and Russia alone will account for over 30 % of the growth in the global economy in 2007. This is a far cry from the central role which the US economy was playing in global growth in the late 1990s. So in this sense something fundamental has changed, and this is what Claus and I are calling "recoupling". This situation can be observed quite clearly in the two charts which follow, which are based on calculations made from data available in the IMF October 2007 World Economic Outlook database. Now, as can be seen in the first chart the weight of the US economy in the entire global economy has been declining since 2001 (and that of Japan since the early 1990s). At the same time - and again particularly since 2001) the weight of the soc called BRIC economies (Brazil, Russia, China and India) has been rising steadily. This is just one example - and a very crude one at that - of why Claus and I consider that demographics is so important, since it is precisely the population volume (and the fact that they start the process from a very low base, ie they were allowed to become very poor comparatively, for whatever reason) that makes this transformation so significant.



Again, if we come to look at shares in world GDP growth we can see the steadily rising importance of these economies in recent years.




So this is another type of "recoupling" (a very fertile metaphor this one, I think), and one which analysts like Richard Katz are missing I feel, when they continue to put considerable emphasis on the "round tripping" component in Japanese exports to the Asian Tigers and China (in the sense that many of these may be components for assembly and subsequent re-export) since I think we are seeing a growing element of autonomous local consumption driven demand in places like S Korea and now increasingly in China itself. Komatsu's recent decision to build a new factory inside Japan wasn't primarily driven by anticipated demand for earth moving equipment in the US economy it seems to me.

Komatsu Ltd., the world's second- largest maker of earth-moving equipment, said it will spend 5.3 billion yen ($48 million) to build a factory in central Japan to make excavators to meet rising overseas demand.

The company will spend the money on acquiring 104,500 square meters (26 acres) of land near Kanazawa port, and on construction costs of the factory, the Tokyo-based company said today in faxed statement. The plant, which will build excavators weighing 400 tons, will start production in August 2009 and will have a capacity to make 30 units annually.

Komatsu's investment follows domestic rival Hitachi Construction Machinery Co.'s move in increasing production capacity for giant excavators used in mining projects as demand expands in Indonesia, China and Russia. In January, Komatsu constructed its first domestic factory in 13 years to make large- size wheel loaders and dump trucks used in mining.


And looking at Japan exports in depth I really don't really see this indirect US dependence effect. Europe, China and Asean are all now very important for Japan, in their own right, and quite apart from the US cyclical connection. and then, of course, there will be India.

At the end of the day Nouriel Roubini certainly is right in the sense that most of the EU isn't decoupled in any strong sense from cyclical movements in the US, but I don't feel he is addressing the extent to which the global role of the US is reducing. Two processes seem to me to be underpinning this deline. Firstly there is the rise of the giant pandas (or pehaps the "bears", "pandas" and "elephants" following the "tigers" and the "lynxes", but well, I don't know, perhaps we are now gradually talking about all the animals imagineable across the entire human "zoo"), and secondly there is the ongoing slide in the dollar. Of course indirectly - and via the intermediary of a temporary upward structural shift in the euro - the former is really producing the latter as the Bretton Woods II architecture gets steadily ground down. So both the US global GDP growth share and its absolute value share are now on the slide, and with that, logically, the level of direct coupling between the global business cycle and the US one. Since, with domestic US consumption taking a hit from rising energy costs and the internal credit crunch, it may in fact be the case that a US economy in need of exports on a greater scale for growth may well be more coupled to the rest of the world than previously and in that sense some of the arrows on the flow charts may have changed direction.

Basically in both these cases does demography seem to be playing quite a central role, since it can help us understand both why those economies which have median ages over 40 (which of course are little by little becoming a larger and larger proportion of the G23 economies - although notably NOT the US, the UK and France) are not able to shoulder the burden of actually driving the global economy and are instead destined to ride on the backs of those economies which may be considered to form part of the new group of emerging economy growth leaders. As I say demography helps us understand both these phenomenon (and possibly even how they are interconnected) since the key factor in explaining why it is the above mentioned group of emerging economies who are leading the charge (and not another group, always stripping out, of course, those commodity driven economies which are themselves riding on the back of the global growth boom) is the attainment of near- or below- replacement fertility and with this the possibility of a "normal" (which is not we can now see <> as understood by neo classical economics) expansion wherein domestic demand begins to achieve the status of an autonomous and independent driver of growth. This process is also known as the demographic dividend and I have recently explained in detail how this is working out in the case of Argentina (and here in the case of Turkey).

So we do have some sort of "recoupling" process at work out there, but it is not clear at this point just how sustainable this is. China's economy is, for example (and is extremely well known) extraordinarily dependent on exports, and even if some of the weight of these exports can be shifted towards Europe, it is not clear that China can resist a slowdown in both Europe and the US, and clearly it is not clear that Japan can resist a slowdown in the US, Europe and China etc etc.

So even if the global economy is now recoupled when compared with the position we had at the end of the 1990s this does not mean that it has become "uncoupled", indeed as I have been arguing repeatedly globalisation now means that the global economy as a whole is more tightly "coupled" now than it has ever been.

There is another detail which I would wish to draw attention to here before signing off, and that is that not all the emerging economies are alike. I have already suggested that methodologically it may well be necesssary to strip out the high fertility oil exporters (Nigeria, the gulf states, Venezuela etc), but we also need to think about the cases of those emerging societies which have now had below replacement fertility for two decades or more. This would be principally the whole of Eastern Europe (including Russia) and of course China (with the one child policy). What is not clear in these cases is where they are going to get the labour supply from as we move forward to fuel both catch up growth in labour intensive sectors like construction and some kinds of manufacturing industry (the lower value added components) and the new human capital in sufficient quantities to make possible the rapid transition from one sector to another which is necessary to achieve the potential high rates of productivity growth.

This is why what has been happening in the Baltics and Bulgaria (where growing labour shortages coupled with construction booms are sending inflation rapidly through the roof) seems to us to be so important. The Baltic economies may - to use the words of the Economist - be "pipsqueaks", but they are a very useful and important laboratory. What, we need to ask ourselves, will happen if the "Balitic syndrome" spreads to Romania, and then to Poland? And what if Russia then follows in a domino like chain? And what, oh woe of woes, will happen if this process (really I would argue when, rather than if) reaches China (and just how far are we away from this possibility?). So with these rather preocuppying thoughts I will leave you on this rather grey and wintry day here in Barcelona. Recoupling is taking place, but which of the chain links will hold, and which will break. Aha, if only we knew!

Tuesday, November 13, 2007

Japan Q3 2007 GDP

Well Claus will doubtless be commenting in depth on the provisional data which have been released today, so I will limit myself here to simply sticking up a couple of charts.

Basically the headline news is that the Japanese economy expanded an annualized 2.6% in the three months ended Sept. 30 (or a quarterly increase of 0.6%) following a revised 1.6% contraction in Q2, according to data released by the Cabinet Office in Tokyo today.

Really after the surge in industrial output in August (and September), and the comparatively good news on the exports front recently (August and September), this outcome was not entirely unexpected, as Claus indicated in his recent lengthy post.



What seems to stand out from the chart is that quarterly GDP growth was tapering down during 2006 until we hit the 4th quarter. Then there was a sudden surge, following which the former trend has been resumed, with a good deal more volatility. This picture becomes even clearer when we smooth out some of the volatility and look at the quarterly year on year chart.



As we can see, the long march upwards which characterised 2005, and lasted into Q1 2006, started to weaken in Q2 and Q3 2006, but then things suddenly changed course in Q4 with another strong upswing, an upswing which did not last, and what we have seen since then is a Japanese economy is steadily weakening, and which is now almost exclusively dependent on the fate of exports for determining its momentum. Basically the narrative we could read into this is that had Japan been a "normal" economy (in textbook terms) and not an "elderly" one, then in the middle of 2006 (in Q2 and Q3) we could have expected domestic consumer demand to swing into action, and take over some of the load as the big push from exports, and export driven investment, started to wane. But consumption didn't play that role, and it won't now, and it isn't going to, since Japan is not a "normal" economy (in the neo-classical theory sense), but a rapidly ageing one, struggling to come to terms with the effects of over 30 years of sub replacement fertility. It is dependent on exports for the growth it gets, and when exports slow, as they may well be about to, then watch out. This is what all the current sentiment indexes and other short term indicators seem to be telling us right now.

Monday, November 12, 2007

Japan Consumer Confidence Index October 2007

Japanese consumer confidence fell in October, and to the lowest levels in three years. I guess there is nothing especially surprising about this given everything else we have been seeing of late, but it is another data point.



Japan in fact maintains two separate consumer confidence indexes, one is an index that measures confidence among households with two or more people, and this slid to 42.8 points in October from 44.1 in September, according to data from the Cabinet Office, while the other, which measures confidence among consumers including single-person households slid to 42.9 last month from 44.1 in September. Whichever way you look at it confidence is falling.

In fact all the sub indexes are also down, with concern being expressed about price rises in basic consumer products like food (despite the general deflationary environment) and about wages and employment conditions.

Friday, November 09, 2007

When Will Japan Intervene?

Well my dear JEW readers, as the global dollar sell-off continues in full swing against all major currencies we are moving into a territory which I just a few days implied to be wholly theoretical. You see, while indeed the USD has been trading at all time lows against Sterling and the Euro (to name but a few) the recent day's fall against the Yen has been particularly drastic. In time of writing and as such in real time the Yen is trading at a whopping 110.7 per USD. Now if that does not mean anything to you then have a look at the graphs I field in my recent large analytical post. As we can see the USD/YEN pair has moved from a little over 120 in May 2007 to about 110 today. So what does this mean? Well if you have a close look at my note linked above I emphasise the probability that Japan might actually intervene to keep the Yen down as we move closer to a USD/YEN of 100. But is that really probable? This is of course a pretty important question in itself but the mere fact that this is now being considered is sure to bring all kinds of spectres to the forefront of Japanese policy makers' mind.

(quote Bloomberg, and here)

The yen may rise to 100 per dollar by the end of 2008 as credit-market losses prompt investors to pare purchases of higher-yielding assets with loans from Japan, Lehman Brothers Holdings Inc. and Deutsche Bank AG said.Slowing global growth will also cause traders to pare purchases of riskier securities in so-called carry trades, Jim McCormick, head of currency research in London at the fourth- largest U.S. securities firm, said in an interview in Tokyo. He predicts the yen will climb to 100 by the end of 2008. Deutsche Bank forecasts 97.5 per dollar within 12 months.

Japan's currency gained 5.8 percent against the dollar this year as global stocks fell and U.S. investment banks reported losses linked to defaults on loans to homeowners with poor credit histories. The dollar slumped to a record low against the euro today on speculation widening credit-market losses will prompt the Federal Reserve to cut its benchmark interest rate for a third time this year. ``In our view, the yen is certainly undervalued,'' said Koji Fukaya, senior currency strategist at Deutsche Securities, the Tokyo unit of Deutsche Bank, the world's largest currency trader. ``The tightening credit market will weigh on the yen carry trade.''

Now, let me first address this idea of Yen 'undervaluation' and note two important issues. Firstly, what does it actually mean that a currency is over- and/or undervalued? I mean, in the concrete calculations; do we then incorporate the complex and essentially unique nature of Japan's demographic situation? Secondly and perhaps most importantly, an appreciation of the currency is associated with two things (all things equal); deflation and reduced competitiveness relative to the external environment. At this point many would be at pains to point out the lag with which these effects occur and as regards to exports many would even argue that this is exactly what the world needs; i.e. that Japan does its part in re-balancing the books. Alas, this is also part of the whole point since is this really realistic?

Finally, let me address the formal question with which this entry started. When will Japan intervene, if at all? This is a tricky question to answer and much will depend on the degree and abruptness of the current slide in the USD/YEN. But I will say this. The risk that Japan is now moving into a period of subpar growth is very high and this is only going to exacerbate the potential downside as global liquidity move in expectations of re-balancing. What the actual number is here is anybody's guess and by all means it is not even sure that Japan will intervene but take note. If the slide is as violent as it appears now the USD/YEN will see 105 in a couple of weeks and this won't go down well with the current economic environment at the moment. Personally I don't think (and certainly don't hope) that it will come to this but we are moving closer to what, only a few days ago, seemed a mere academic discussion.

Thursday, November 08, 2007

Machinery Orders September 2007 and the Economy Watchers Index in October

Well, this week really has been a pretty gloomy and forlorn one in Japan, since following hard on the heels of the zero reading on the leading indicators index we now have the September machinery orders data, and the latest edition of the Economy Watchers index (Japanese only at present). First the machinery orders.

Machinery orders fell sharply in Japan in September, far more more than economists had forecast, and this may well be a sign that companies are reducing investment as demand wanes.



Machinery orders in fact declined a seasonally adjusted 7.6 percent to 958.7 billion yen ($8.5 billion) from August, which was the lowest level since May 2005, according to data from the Cabinet Office today. Machinery orders are often thought to indicate corporate investment in about three to six months. Total orders fell from 3.6% in the third quarter, and overseas orders fell 2.2%, but demand from domestic private customers was a plus and grew 3%. The big hit was in government orders, which drpoode a whopping 26.2%. In fact the volatility in government orders makes this data very hard to read, and anyone with any insight into just why this should exist in this way, please feel invited to drop a comment.



One explanation for the downturn is that the recent financial-market turmoil and the yen's 8 percent surge against the dollar since July may have deterred companies from ordering more machinery in September. Certainly the continuing slide in the value of the dollar will not be generating an overly enthusiastic and optimistic atmosphere among exporters.

The quote of the day, tucked away in the Bloomberg coverage, is certainly this one:

``My advice to investors is to fasten your seatbelts,'' said Hiromichi Shirakawa, chief economist at Credit Suisse Group in Tokyo. ``Orders peaked in July, and we're not expecting a rebound until the second half of next year.''


And meanwhile domestic demand remains as weak as it ever was. More confirmation of this is available today with the issuing of latest edition of the Economy Watchers index. Japanese workers, consumers and small businessmenhave become increasingly pessimistic about the current and future economic conditions in Japan according to a survey released today by the Cabinet Office.

The main index of the Economy Watchers Survey fell 1.4 points to 41.5 in October, the lowest reading since March 2003 and the seventh straight month of decline. The index, which gauges the mood among ordinary Japanese workers who can observe economic developments firsthand such as taxi drivers and shop keepers, has now been below the boom-or-bust line of 50.0 for seven straight months.



Three subindexes that dropped in the month were the household spending index, which fell 0.4 points to 41.3, the corporate index, which declined 2.5 points to 41.0 and the employment index, which dropped by 5.0 points to 43.8.



In addition the housing outlook is turning increasingly - and almost alarmingly - negative. In September Japan's housing starts fell by 44% (y-o-y) and this followed falls of 43.3% in August and 23.4% in July. The main cause of the rout was a new building standards law introduced in June. The law was aimed at ensuring building safety measures, but the apparent lack of adequate warning before the law was enforced caused a sudden, drastic increase in paperwork to get a building permit, and a sharp delay in initiating new buildings. But this kick-stop on the permits front now seems to have initiated a more general problem, since it coincided with the global tightening in bank lending conditions.

The watchers survey showed 41.7% of survey respondents said housing-related spending was worse than three months ago.

Is Japan Recession Bound?

Well as Scott said yesterday it is "hard to see how Japan can avoid a recessionary 4th quarter". This is also the gist of Claus's much longer analytical post, and I cannot but agree.

So at this point I think we need to bear a number of issues in mind. The principal one of these is that recent Japanese recessions have tended to be messy long-drawn-out affairs. In fact Japan has had three recessions since the bursting of the stock and property bubbles in the late 1980s early 1990s. The first lasted 32 months from March 1991 to October 1993, and the second dragged on for 20 months from June 1997 to January 1999. The most recent recession ran for a full 14 months from December 2000, following the bursting of the information-technology boom and the impact this had on exports and capital investment. This is perhaps why all those Japanese investors and businessmen are looking with something more than a simple wary eye on the sub-prime turbulence which is coming out of the United States at the present time.

But if Japanese recessions have grown longer, and more intractable, and deflation has proved to be persistent and equally intractable, and if interest rates, even in the longest boom since the end of the 1980s bubble, still have not been able to get raised above the 0.5% threshold, then isn't really time that more people started to ask themselves more questions about just what is (and has been) going on in Japan. Is it just a coincidence that Japan now has the highest median age on the planet? Is it really the case that 30 years of below replacement fertility is so harmless as almost everyone seems to believe? Isn't it worth just allowing ourselves to ask the question whether all this might not be somehow interconnected, because one thing is sure, until we get the right diagnosis there is very little chance we are going to be able to apply the adequate medicine and cure. Now what was it you said that patient had doc? Appendicitis, or simply indigestion. Somehow I think the answers we let ourselves give to the question we allow ourselves to ask might turn out to be pretty important when it comes to the outcome we may lead ourselves to expect.

Wednesday, November 07, 2007

Japanese Leading Indicators-all negative

Just to follow up on Edward's chart, I had assumed on seeing the news item about this index that the result of zero was due to an equal number of positive versus negative components. That is not the case...if you follow the link in Edward's post you will see that every single available component was negative. So the headline number is a bit misleading if you are not familiar with the details of how the index is calculated. It's hard to see how Japan can avoid a recessionary 4th quarter.

Tuesday, November 06, 2007

Japan Leading Index Falls To Zero

Japan's broadest indicator of what the outlook for the economy may be fell to the lowest level in a decade today, signaling growth may be in the process of grinding to a halt. The leading index was zero percent in September, according to the Cabinet Office in Tokyo today. A reading of below 50 is normally considered to indicate that the economy may slow in the coming three to six months. Since the Japanese economy already was at stall speed in Q2 2007 this is not good news.




I will leave this as a brief note at this point, since Claus really said it all in his very extensive post yesterday.

Sunday, November 04, 2007

Where is Japan Heading?

[This is a big one and if you are not in the mood I recommend that you just skip down to my summary which should give you the main thrust of my argument and analysis. This note also features over at my personal weblog Alpha.Sources.]

I would imagine that the answer to the question above remains quite at the forefront of many an investor's and economic analyst's mind. In this entry I will try to most modestly give interpretation of the road which lies immediately ahead for Japan's economy as we are about to receive Q3 GDP numbers on the 13th November. As per usual I am basing my analysis on the firmly established principle of standing on the shoulders of giants as well as I will field my traditional array of monthly charts updating the evolution of prices and household spending. Moreover, I will also, in the light of comments received outside the walls of the JEW and Alpha.Sources as well as the general interest in the subject, give my interpretation of where the Yen is going to be positioned in the months and quarters to come. Lastly, I will note the rather large and ugly downside which has emerged in the realm of the housing market and residential investment since this might just be the push which shoves Japan into a near recession path as we get to Q4 2007. I will finish off with a summary including remarks on the future course of policy at the BOJ as well as some brief comments on what seems to be clear signs of reform fatigue in Japan as well as the potential of uncertain times at the BOJ with respect to governance.

As you will see, Edward already has some snippets up (on JEW) on September exports, industrial production, and retail sales as well as the labour market. If we take a brief look at what these data releases have to say we can see that the outlook is steadily beginning to look ever so wobbly for Japan although, as I will also show below, household spending seems to be making a most welcome comeback. In terms of the external position we had one of the most negative news points as exports slowed quite significantly. Yet, we must always remember that there are two sides to the trade balance and an offsetting decline in imports helped to keep the trade balance to a record surplus. Yet, this does confirm the general outlook that the external environment just might be cooling off into the rest of 2007 from what has also been a red hot frantic pace. What remains is clearly that since external demand constitutes the main driver for Japan's economy any faltering on this account will translate swiftly into growth rates. On industrial production the picture is still somewhat clouded by the earthquake a few months back and as such the decline in September's IP comes on the back of a surge in August and should really be read accordingly. What should be noted however, as you can also see by the graph Edward fields is that IP still remains high relative to the beginning of the year which suggests that the readings should be taken with a pinch of salt. In this way I would not be surprised to see a further drop in October which would pair the surge seen in August and bring us back to a point below the high levels of Q4 2006. Finally, on retail sales Edward reported that they managed to push up a small 0.5% increase y-o-y thus showing some very welcome numbers outside the red for the first time in 2007. Yet, two things need to be remembered here. Firstly, as Edward notes there is a low base effect here since sales in September 2006 were comparatively low; this will become even clearer below. Secondly, the m-o-m evolution showed that retail sales extended a four month decline which goes to show the dynamics restricted on 2007.

Thus enlightened on what has already been noted at JEW why don't we move on to the new stuff. In tradition with my previous notes let us begin with the evolution of prices. Before I show you the chart we should dispense with the non-event that the BOJ chose to hold rates steady the day before yesterday. The statement from the BOJ as well as the recently published Outlook Report (Takehiro Sato has a round-up over at MS' GEF) did not really reveal much as to where we are going in terms of a rate outlook but did explicitly and quite as expected cite the global economic trend in credit markets as a source of uncertainty. In reality, a recent small but concise article from The Economist pretty much sums up the situation in its title sentence; The Bank of Japan would like to raise interest rates, the economy won't let it. And one of the obvious reasons can be seen below ...

As can readily be observed Japan remains mired in deflation with all three indices tugged firmly in negative territory. Regarding the officially deployed price index (core CPI) which is the CPI excluding fresh food (green line) we can see that this is virtually flat at -0.1%. In this respect, do also note that you, my dear reader, are getting a special treat here at Alpha.Sources (and JEW) with the inclusion of the index stripped of energy and fresh food. In this way we should be especially focused on this measure in the light of the fact that oil and gas are trading at very high levels at the moment. This of course does not mean that this can be used to anything as regards to economic/financial position making but it does go to show the 'real' price dynamics in Japan in the sense that it tends to be biased toward the effects of internal demand and activity in Japan. In general and on the probability of a positive yearly inflation reading in 2007 this has been somewhat of a mute point and as such a virtual improbability since the figures for the summer months came in. Regarding the official forecast, the just published Outlook Report sliced the previous F3/2008 forecast from 0.4% as it was made in April to 0.0%. If you are in to the more arcane matters of inflation forecasting the Outlook Report also fields projections for inflation readings in 2009 based on estimates of the output gap. Morgan Stanley's Takehiro Sato also ventures the official in house projections from the US investment bank. The bottom line seems to be that we are going to see a 0.4% inflation rate by F3/2009. In my honest opinion, I believe that such forecasts are complete word salad since no-one can say what will happen during 2008 let alone as far ahead as 2009, yet this is the forecasts as they are and we should keep them in mind. On balance, I don't see Japan escaping deflation anytime soon and this most emphatically goes if we home in on the core-of-core index (i.e. excluding fresh food and energy). An upside to this call would a be a pass through of high energy and base commodity prices but so far such effects have been muted, the anecdotal evidence on Tokyo's mayonnaise prices notwithstanding.

If we move on to indicators for domestic demand (living expenditures) the figures noted above on retail sales promise to bring some good news relative to what we are accustomed to in this area. Below I field the traditional three charts; one of the bread-and-butter y-o-y figure reported by the media, one of the seasonally adjusted m-o-m evolution, and finally a real monthly index (100=2005) to give the big picture.

If we look initially at the first figure which displays the headline number from the official statistical sources we note that the last two months have shot up significantly (although commentators seem to be attributing this to the illusive 'weather' effect). More importantly however, at this point we need to go back and consider what Edward said about a low base effect regarding the retail sales. In this way, the September reading on living expenditure has 'low base effect' written all over it but nevertheless we should not deny that it was an overall positive reading which as I said is most welcome reading. If we turn to the m-o-m figures however which are furthermore seasonally adjusted we indeed note a positive reading which extends a two month consecutive positive reading after three negative readings. Also do note that the recent two months' positive readings are below 1% which should not be interpreted as bad in itself but merely a reflection of the relative measures here. Finally, we need the big picture I think to finish off and in this way we can see that the long term index edged up but is still below the levels of Q4 2006 and the first months of 2007. As a very final data point Ken Worsley also informed us that auto sales rose in October by 2.0% which is the first gain in a very long time. In summary, on domestic demand and although the figures above form a clear basis for, at least a slight, optimistic sentiment household spending in Japan is still, by all measures, sluggish. The point is quite clearly that given the nature of Japan's demographic profile we are unlikely to see domestic demand be the main driver of growth which is then to say that on the margin the Japananese GDP account is not going to be carried by households spending. Regarding actual forecasts I put forward the notion a while back that I didn't think the official and widely reported figure for living expenditures would exceed 1% on a y-o-y basis. So far we are looking at a rolling average of 0.92% which of course includes the last two months' rather above par performance. I am consequently sticking to my prediction.

Before moving on to an analysis of the Yen and where it might be heading I want to touch upon another aspect which is weighing significantly on the short and medium term outlook in Japan. Normally and even though global financial and economic analysis has been littered with accounts struggling housing market practically everywhere we have not been hearing a lot about housing in Japan. Of course, we have had steady reports about a bubble in office building prices in downtown Tokyo but that of course masks a much more diversified picture; The Economist linked above marks it down well ...

Although land prices appear to be booming, prices nationwide are falling once sales in Japan's three biggest cities are stripped out.

More generally we need to understand that the housing market and construction in general have not been the driver of the recent 'expansion' in Japan as it has been the case in many other countries; at least not directly although in many ways the issues are interlinked here since the global housing boom has permitted many countries to really wamp up consumer spending which in turn has benefited Japan's export sector and corporate sector in general. The lack of housing dynamic in Japan may be due to various institutional factors but most prominently I think is quite simply the prolonged path which Japan has taken in the demographic transition. These structural points notwithstanding it was recent changes in regulations concerning and essentially delaying housing starts which suddenly made all kinds of skeletons come rattling out of the closet as Housing starts plummeted 43 percent in August; Quote Bloomberg.

Japan's worst housing slump in four decades and rising oil prices threaten growth in the world's second-largest economy, Cabinet ministers said.

``There is concern that a decline in housing investment will become a factor pushing down gross domestic product,'' Economic and Fiscal Policy Minister Hiroko Ota said in Tokyo today. ``I'm more focused on the downside risks to the economy.''

Housing starts fell 44 percent in September and 43.3 percent in August because of stricter rules for obtaining building permits. The government this week said it would relax the regulations after industry criticism that they were too onerous.

This of course looks pretty bad at face value. In order to substantiate this further and as a service to you my dear reader I am featuring below some comments from a Japan mailing forum which I am lucky to be a member of and which contains a lot of very smart observers of Japan and essentially 'people' on the ground. I cannot divulge the name of the commenter but this should matter little in this context ...

Some worse news is hidden in these figures: housing starts on condominiums have fallen 74.8% and even worse, starts on condominiums in the Tokyo area, the locomotive of Japan's real estate business have fallen 85.9%. As well as the worried voices within the industry itself, such as building materials, other voices have begun to be heard expressing clear worry about the knock on effect of these falling housing starts. Some economists are wondering out loud how much falling condominium sales will effect the sales of automobiles, for instance. Real estate in Tokyo, and to a lesser extent several other big cities such as Nagoya, has been the only spot of joy in a general murky panorama of Japan's internal economy.

As should be pretty clear and although the full extent of this is not known it has basically opened up a virtual abyss of downside regarding Japan's economic performance going forward.

As the final topic in this installment I promised above to also have a look at the Yen; where it is now, what drives it, and most importantly where it is likely to go. Let us begin with a chart to get us started which plots the Yen against the USD, EUR and AUD; remember that the y-axis is denominated in Yen which means that movements up means that Yen depreciates against the target currency.

Regarding the immediate position of the Yen we can see that it has fallen steadily against the three currencies in questions during the past 1 1/2 year although of course the recent assertion against the USD on the back of the expectations and now real evidence of the Fed's rate cuts. This also underlines the rather peculiar situation at the moment in global FX markets where the Dollar is taking a beating against almost everything which moves. In this immediate context it means that a wedge has now developed between the USD/YEN which for all intent and purposes could look as a good buy (long position) and the EUR/YEN which looks more like a sell (short position). Such traditional logic however should be applied with extreme caution since when we are talking about Japan where a whole gamut of structural and cyclical factors tend to exert a rather unique influence on the movements in the Yen. I am surely not able to give an exhaustive account of all these factors but here are nevertheless some remarks. As a very first frame we need to consider the probability that the BOJ is going to raise rates and more importantly close the interest differential gap with the rest of the OECD. I think this is unlikely which as an initial intro should give you an impression to where I see the Yen. Apart from this there are three factors I want to emphasise.

The first issue which should immediately be noted is the carry trade which is an inbuilt and lingering phenomenon of wide global interest differentials. A lot of things have been said about the Yen carry trade, whether it can continue to keep the Yen subdued and subsequently what will happen if it unwinds? One thing which is important to note here is the distinction between an overall normalization of interest rates in Japan which in itself would effectively flush out carry trading and then the potential for unwinding of carry trades at any given point in time. In this way, it is crucial to understand that even though the structural pre-requisites for (Yen) carry trades are likely to linger you can still get burned! This has perhaps best been substantiated since Spring where the credit market turmoil began and where volatility returned to markets. In this way, the carry trade and thus also the Yen tend to be synonymous with risk taking and as such considerable volatility in the Yen seems de driven by the general risk appetite in the market. In general on the carry trade we should also note that flip side of shorting the Yen where especially the Aussie and Kiwi (NZD) have been all time favorites for Japanese retail investors and others as currencies being 'carried'; the chart above of AUD/YEN substantiates this. The bottom line is that the carry trade still seem to be weighing on the Yen (except it seems against the USD at the moment) albeit with the important qualifier that the recent market turmoil has made gung-ho tactics substantially more hazardous.

The second thing I would like to emphasise is related to the issue of carry trade and concerns the structural decline in Japanese home bias whereby Japanese investors, retail as well as institutional, tend/will tend to move funds into foreign denominated assets which would then tend to hold the Yen down. Now, the argument for the decline in home bias is essentially vested in a long term view and economic analysis but signs of a decline in home bias can also be found in the present. The most enticing evidence comes of course from those notorious Japanese housewives who, equipped with some basic FX trading software, have been hard at work to bet against the Yen and as we have seen especially Kiwis seem to have been a favorite dish. Anecdotal evidence of the housewives seem to have abated somewhat in the recent months but what remains is a trend which indeed should be watched both as regards to retail investors and thus those savvy housewives as well as of course institutional investors such as pension funds and perhaps even a sovereign wealth fund (SWF) if and when it comes.

The last thing I would like to note is something which has emerged on the back of the recent rather violent decline in the USD against almost all currencies and thus also the Yen. In this way and in the context of how external demand and in this way also the US economy is crucial to Japan's growth prospects we must also consider the probability that the authorities in Japan are going to intervene if the Yen drifts up too much. A week ago I voiced this probability noting that anything close to a USD/YEN rate of 100 would bring out the ropes and lassos. Recently, Morgan Stanley's Stephen Jen also put the limit at 100. What is more important however than the limit itself is of course the idea of intervention. More generally, which I will treat in more detail in my summary below the whole structure of the BOJ is entering somewhat of a limbo as we move closer to the time where the current governor Toshihiko Fukui is to be replaced.

The bottom line on the Yen is that structural forces are likely to keep the Yen down. First and foremost is of course the whole inbuilt economic situation which effectively seems to hinder any attempt by the BOJ to raise rates although as well will see below markets are mumbling about a quick December raise. In general, I don't want this to come off as an endorsement of a sure bet on the carry trade and mindless short Yen positions. Especially, the re-emergence of risk aversion would almost surely make such positions (highly leveraged as they usually are) very expensive to keep on the books if the Yen were to shoot up. In line with my promise above and a call on the Yen for the remainder of 2007 I don't see a raise from the BOJ which should serve as a principal indication. Sudden market woes and credit risk sparks notwithstanding an interesting play could be to go for a move of the USD/YEN towards 118-120 from its current level of about 114-115 although of course any talk about Dollar strength at this point and until the end of 2007 and beginning of 2008 seems rather contrarian. As for the EUR/YEN it is trading awfully high at the moment as a result of a Euro on helium and I would really not want to stick my neck out here. If you want more technical advice on FX trading Dailyfx.com is my weapon of choice.

In Summary - Movements at the BOJ and Political Risks?

As I have already ostensibly hinted above I don't see how the BOJ will be able to raise rates in 2007. There are two principal reasons for this. Firstly, deflation is not likely to dissipate and especially not with economic momentum destined to slow down. This then brings me to the second reason which relates to the extent of the economic slowdown which seems certain to be rolling in at this point in time. It is really difficult to say at this point. Industrial production as a leading indicator of corporate capex and activity seems to be holding up as well as household spending has been showing some positive signs lately. Yet, coupled with what seems to be a slowdown in external demand as well as a looming correction in residential investment it seems as if the ground is getting shaky indeed. Moreover, I am uncertain for reasons stated above that domestic demand will remain much of a driver of growth since the momentum measured exclusively on 2007 is one of a down trending path. On industrial production we will just have to wait and see how much downward it has to go on the back of the earthquake rebound in August. The bottom line on the economic side of things seems to indicate that as regards to economic fundamentals the BOJ will find much difficult to wring that 0.5% refi rate upwards. Moreover and to add to the uncertainty, it seems as if the political situation might also be turning somewhat sour.

Consequently and before I sign I want to briefly mention another risk which is emerging and which is contributing to the uncertainty is the general political situation both in terms of domestic policy and also most emphatically within the ranks of the BOJ and thus monetary policy decision making. Concerning the former we need to think back to the ousting of Abe which really put the spotlight on a political life in Japan riddled with scandals and what can only be interpreted as poor and half made decisions. Moreover and very important the sacking of Abe also revealed a public which by and large had lost confidence in the politicians' ability to do something with the issues facing the Japanese society and economy. Of course this is past us at this point with Fukuda entering as new Prime Minister but as Robert Alan Feldman brilliantly puts down in just a few words there is now a significant risk of 'political backsliding' and essentially stalemate. The first point I would like to point out is the paralysis which may emerge as a function of a split majority divided on the two chambers in Japan's bicameral system ...

Policy paralysis risk has already emerged in some areas, such as defense policy. In seeking to force a general election, the opposition party, the Democratic Party of Japan (DPJ), is using all possible methods to pressure the government. A key part of this strategy is to use the power of the Upper House, where the DPJ recently won a majority, to stall appointments of candidates for government posts. Many such appointments require the approval of both houses of the Diet, and so the capture of the Upper House by the DPJ gives that party veto power over appointments.

Yet, much more significant is the stalemate and as Feldman puts it 'the backsliding' as Fukuda sees it appropriate to roll back a lot of the initiatives instigated during Abe's reign.

The biggest policy risk is backsliding. Already, the Fukuda government has reversed course on several important reforms. The new government wants to freeze the legislated increase of medical user charges, continue road tax earmarking, and focus on tax hikes (rather than spending cuts) as the main source of deficit reduction. Moreover, there is persistent talk of a major supplementary budget, in order to pay for policy changes. Once the momentum for a supplementary budget grows, it is very likely that many politicians – who face a general election soon – will opt for more spending.

On top of the current rigid state of domestic policies another slight risk has emerged that the BOJ might end up without a governor come spring time 2008. The reason for this shores up, as Takehiro Sato tries to explain here, on the same political quagmire Feldman refers to above where the Democratic Party of Japan holds a majority in the upper house and Fukuda's Liberal Democratic Party which still controls the lower house (the Diet). Normally and according to Japan's constitution the Diet holds precedent but not in this case as regards to the appointment of the BOJ's executive posts. This has thus created a situation in which the DPJ might use their majority in the Upper House to stall the appointment of new BOJ executives as the current members are up for replacement in the spring. The concrete situation as it may unfold is this;

But if the selection of the next BoJ leaderships is postponed because of a general election, the Bank would inevitably face its own form of political vacuum. It would have to conduct the MPMs in April (8th-9th, 30th) and May (19th-20th) without a sitting Governor or Deputy Governors (i.e., with a six-person board), or under Article 23 it is possible that the Cabinet would extend the terms of the incumbents in the interim.

What this means for the BOJ policy is difficult to say but I tend to agree with Sato that under such conditions anything but an abrupt change in economic fundamentals (one way or other) I would meand that policy changes would/should be suspended. This however opens a new risk in the sense that the current and presiding board at the BOJ might see its December or January meetings as the only possibility to raise for quite some time thus ending/entering the year at 0.75%. The reason for this scenario would seem to be Morgan Stanley's high probability forecast that Q3 GDP numbers due on the 13th of November will show a respectable growth clip. As I have argued above I am somewhat uncertain about this but given the underlying political dynamics I concede that the risk has emerged for a hike to 0.75% in December or January although I am not ready to take it aboard in my general forecast.