Japan's Savings - Going for Yield

The idea of having a large pool of funds to place on the world's asset markets in order to livf off of the derived income seems alluring to most I think. In fact, you could argue that it is precisely this allure and many an economy's pursuit of it that is causing much of the current debacle in the global economy. In Japan's case we are arguing as a part of our ongoing observations that Japan is now dependent on exports. In reality Japan has been dependent on external demand to grow for some time now. More specifically we have, here at JEW, argued why we should look at Japan's age structure to find the principal reason as to why Japan has the growth profile it has. The point is simply that when the labouring cohorts of the economy are declining in number with such a pace as we are seeing in Japan domestic production and productivity will have to be channeled towards external demand. I see no coincidence in all this but a quite natural consequence of the fact that domestic capacity in Japan is now declining and will continue to do so for the immediate future. As such, if Japan is ever to keep the ratings agencies at bay and if Japan is ever going to have hope, even a fool's hope, of servicing the pension demands of her citizens it is necessary for the economy to be biased the way it is. Of course, and this I have been pointing out extensively, the problem is that Japan is not the only ageing economy and in fact if we extrapolate the demographic developments a bit we are going to end up with a lot of exporters and no one willing to run a respectable external deficit. This global bias towards one end of the intertemporal spectrum of the current account is a very interesting theoretical theme which I intend on investigating further as I go along. In a recent post I elaborate further on this topic and especially the following rather lenghty quote is important to take away in terms of my main argument.

"This 'crowding' of countries in one end of the intertemporal spectrum of savings/investment and consumption is not coincidental and perhaps most importantly it will result in important global externalities. The drivers of this tendency (to the extent that it exists) need to be found in terms of life cycle dynamics aggregated to population levels. At this point I feel that we are far away from really pinning this one down. However, one part of it is related to three potential hypotheses that I am working with in terms of consumers life cycle pattern. 1) people do not dissave to 0 since they do not know when they will end their existence. 2) Rising life expectancy will induce consumers to save more and longer during their life cycle. 3) Ageing societies are likely to, one way or the other, promote forced savings in order to ease the societal burden of the intergenerational skewness as the dependency ration rises. If we add this together with the decline in home bias currently observed in Japan (the oldest society on earth) we consequently run smack into the externalities I was talking about before. Consequently, if we go back to the point on intergenerational preference for spending we need to understand that ageing economies will indeed attempt to invest their accumulated savings. They have to in order to earn income but they cannot invest it in their domestic economies. Thus we have the externality in the sense that as the world ages we are likely to see a process by which more and more countries will develop a propensity to 'export' in order to sustain growth."

So, what does it mean to be dependant on external demand? Traditionally we think of Japan as being dependent on exports of tangibles but this does not represent the complete picture. To be sure Japan is extremely dependent on exports in the form of a trade surplus but on the margin another factor is important too; the income balance.

Whether the graphs above tell the story of an ageing economy is of course debatable. I clearly think it is and I believe that there are sound theoretical reasons back my thesis. This point notwithstanding we can clearly see how Japanese savers have stepped up their holdings of foreign assets and given the impressive growth of the global economy the income earned has certainly been quite respectable. However, why invest abroad when you can invest at home? Well, I have always answered that question above but two seperate headlines in Bloomberg very neatly sums up the situation. First, we learned from Bloomberg reporter Patrick Rial that Japanese companies lost investors a hefty $3.2 billion the fiscal year ending this April and secondly we got the news, referring to the charts above, that Japan was the largest holder of foreign assets in the world. I don't think it takes much of an economist to connect the dots here and if we accept the fact that Japan's deflation problem and its subsequent low interest rate are related to the country's demographic profile it should not be too difficult to see what is going on.

The graphs above will be familiar to many a financial trader as it shows the lingering negative trend in Japan's main stock index. Of course the second index could just as well have been made with 2003 as a starting point in which case we would be observing +100. In this light it will be interesting to see just how far the Nikkei will fall this time around as Japan enters yet another tough patch in terms of economic growth.

It is thus not so strange that Japanese savings are rather eager to go abroad and why we consequently have observed a very rapid decline of home bias amongst Japanese investors. However, this decline is not so much a story of equities but rather one of debt (0.5% interest rate remember) not least the samurai bonds; a topic which I have addressed on several occasions.

The graph above speaks a clear language I feel and even though the share of equities have nudged upwards recently the majority of Japanese portfolion investments still go into debt.
Lead by a suffering Citi Group in the wake of the credit turmoil the sale of yen denominated bonds is thus estimated to have tripled in 2007 from 2006. Part of this was no doubt due to the fact that spreads in Japan offered significantly more calm straits than the credit crunch ladden debt markets in Europe and the US but it is also a simple reflection of the fact that Japan has the spare capital. In this way and as a market mechanism Japan's role here is no different from when one of those much debated SWF dares to venture a stake in rebuilding the balance sheet of a tarnished knight from the US financial service sector. In the context of the credit turmoil Reuters also reported how market participants are well satisfied with the state of affairs;

Dealers in the Samurai market say investors remain keen to buy the bonds -- issued in Japan by foreign entities -- because of the higher yields they now offer and because they see little risk of big U.S. banks and investment banks defaulting.

We can always quibble about just how secure those US investment banks are (well, if Bear Stearns is anything to go by I would say very!) but from Japan's point of view and in the grand scheme of things with a debt/GDP ratio of 170% the income earned on these instruments are quite vital. In fact, notional evidence suggests that Japan may well be an asset managers wet dream in terms of securing funding. A Bloomberg piece fresh in off the wire consequently alerts us to the fact that hedge funds are also dotting down Japanese savings for a source of capital. Obviously, these money need to earn a return though and this is where it all gets very complicated since what happens when everybody wants to be Japan? Coupled with a reserves piling up in China and in the petroexporters' vaults hunt for yield and the subsequent low return and/or overheating are structural consequences for the growth path of the global economy.

A Tendency to Watch

I think that the points above represent important tendencies to watch for both theoretical economists and investors alike.

• For acamedic wonks (such as myself in spe) I think that the idea of the intertemporal current account is important in terms of describing what is going on. More specifically I believe that the tendency of ageing economies to exhibit the same savings/consumption profile in terms of the trade-off between the two is important. If we look at the intertemporality as a spectrum we can say that as the global economy ages economies will tend to crowd in one end of the spectrum and I think that important externalities will arise as a result.

• For investors and asset managers I don't think that the importance need much explanation. However, I do think it is important that investors think about narrating capacity and more importantly excess capacity in terms of demographic age structures. In the context of Japan it means that ageing economies can be a source of capital (hardly news at this point) but it also means that changing demographics in terms of age structure should be incorporated into the asset management framework.
  

Japan Industrial Ouput, Inflation, Household Spending and Employment April 2008

Japan's household spending fell the most in 19 months in April, factory production dropped and unemployment climbed, giving us yet more evidence that Japan's longest postwar expansion may now, slowly but surely, be coming to an end.


Industrial Output

Japan's industrial output fell a seasonally adjusted 0.3 percent in April from March as companies cut production due to rising inventories amid slowing demand from the United States, as well as from other key trading areas such as Europe, according to government data released on Friday. The seasonally adjusted industrial production index fell to 106.2 in April after hitting an all-time high of 110.2 in February.






Industrial output rose 1.8 percent in April from a year earlier following a 0.7 percent fall in March. The Ministry of Economy, Trade and Industry said that companies expect industrial output to rise 4.7 percent in May from April, but they anticipate that it will then fall back again 0.9 percent in June from May.


If these projections are met, the industrial output is set to rise 0.7 percent in the April-June quarter after clocking up the first decline in four quarters in the three months to March. But this is a big if.

"But there are worrying factors that we need to watch closely, which include developments in the North American markets, as well as the trend of consumer spending in Japan," a ministry official said..."In addition, we need to assess if demand for plasma TVs will pick up towards the Beijing Olympic Games this summer,".

Production in the electronics and telecom equipment sector dropped 7.6 percent in April, hit hard by a 47.7 percent drop in output of plasma TVs and a 22.0 percent fall in the output of cellular phone handsets. Output in the electronics parts and device sector fell 3.9 percent, the first fall in three months, hit by a 20.7 percent fall in output of plasma display panel modules and a 14.4 percent drop in output of large liquid crystal display panels.


Output of metal oxide semiconductor ICs (integrated circuits), used in cellular phone handsets, fell 20.0 percent from March ahead of the release of summer models. As a result inventories rose in this category by 5.8 percent in April from March, the biggest increase since September 2006 when they rose 6.6 percent.


Output for the transport equipment sector, which includes cars, fell 1.2 percent in April from March stringing together the second straight monthly fall. Production of medium cars - 1000 to 2000cc - fell 1.1 percent, while production of cars with engines of 2000cc or over fell 4.4 percent. In addition, output of large motorbikes - over 125cc - fell 26.5 percent in April from March, hit by declining sales outside Japan, especially in North America.


Consumer Price Inflation

Japanese annual inflation dipped to 0.9 percent in April, thanks to a short-lived cut in a gasoline tax, but this be just temporary relief and it is quite possible that a new decade-high looms again in May. Political infighting meant that the Japanese parliament blocked the renewal of a gasoline tax of ¥25 per liter, or 91 cents per gallon, giving motorists a month of lower prices in April before the government managed to renew the charge, just as rising oil prices sent gasoline higher.

Core consumer prices, which exclude fresh food, climbed 0.9% from the same period a year earlier after rising 1.2% March, marking the seventh straight month of price gains, the Ministry of Internal Affairs and Communications said Friday.

The core "core" consumer price index - which excludes both food and energy - was back in deflation in April, falling by 0.1% year on year.




Raising expectations for a higher May core inflation figure - core inflation excludes some volatile fresh food prices, - was fuelled by rising inflation in the Tokyo area, which reports consumer prices a month earlier, since in Tokyo core annual inflation rose to 0.9 percent in May, from 0.7 percent in April.



Household Spending


Japan household spending was down 2.7 percent in April from a year earlier, the biggest decline since September 2006, the statistics bureau said on Friday in Tokyo. This was the second straight month of decline and followed a 1.6 percent drop in March. The overall income of households fell 1.6 percent, with the income of household heads up 0.3 percent. Disposable income fell 5.4 percent.




Households cut spending on bread by 6.1 percent after prices rose 11 percent. They spent 14 percent less on spaghetti following a 30 percent price increase in the month.


Unemployment

Meanwhile the labour market is slowly weakening. Japan's job vacancies fell to a three-year low in April and the unemployment rate rose as higher energy costs eroded profits and discouraged hiring.

Japan's seasonally adjusted jobless rate rose to 4.0 percent from 3.8 percent in March, the highest since September, the statistics bureau said today in Tokyo. The ratio of jobs available to each applicant, a leading indicator of the job market, fell to 0.93 last month from 0.95, the lowest since March 2005, the Labor Ministry said.

The number of successful applicants excluding new graduates dropped to 15.3 percent, the lowest since the Labor Ministry survey began in 1963.

Japan Retail Sales

Japan's retail sales rose at the slowest pace in nine months as higher prices for food and energy seem to have prompted consumers to spend less on clothing and other items. Sales climbed 0.1 percent in April from a year earlier, the Trade Ministry said today in Tokyo.



Sales at department stores, supermarkets and convenience stores also declined in April. Sales at the Japan's largest retailers were down 2.2 percent from a year earlier, the biggest drop since July, today's report showed.

It is also worth remembering that since this data is not corrected for inflation, but is in real money terms, and given that inflation has been rising recently, this decline is a bit more pronounced than it might seem at face value. At the moment though it is clear that Japan household spending is losing momentum.

Japan Exports April 2008

Japan's year on year rate of export growth rebounded slightly in April as shipments to Asia and emerging markets helped the nation weather problems caused by the U.S. slowdown and a slowing expansion in Western Europe.

Exports, the main driver of Japanese growth (accounting for more than half of last quarter's expansion), rose 4 percent from a year earlier after climbing 2.3 percent in March, the Finance Ministry said today in Tokyo. But this pace of expansion is still considerably down on the roughly 8% average increase achieved over the four months November to February.




Shipments to the U.S. fell for an eighth consecutive month, and were down 9.1 percent in April from a year earlier. Export growth to China accelerated again on an annual basis, to 14.1 percent growth in April, up from 3.1 percent in March. Shipments to Asia, where Japan sends about half its exports, rose 7.2 percent after gaining 1.8 percent a month earlier, while those to Europe have now slowed noticeably, climbing only 1.3 percent year on year in April.





Imports were up 11.9 percent from a year earlier as oil prices surged to a record, narrowing the trade surplus by 46.3 percent to 485 billion yen ($4.7 billion). Year on year increases in the surplus are now down in the low single digits (4% y-o-y in April, 2.3% y-o-y in March) and this will be noticed, since it is the growth in the net difference between exports and imports which matters for GDP growth.

Growth to a fair number of newly emerging economies continues to be strong, with Vietnam (up 54.1% y-o-y), India (up 36.8% y-o-y), Indonesia (up 27.5% y-o-y), Brazil (up 31.7% y-o-y), Chile (up 80.5% y-o-y) and Russia (up 58.5% y-o-y) all making strong showings.

For some insight into how all this is working out in the emerging markets context see Claus's excellent post this week: Brazil's Economy - Not Emerging Anymore?

Japan Services Index and BoJ Economic Outlook

Despite the relatively healthy performance turned in by the Japanese economy in Q1 2007, the signs are that the impact of rising food and energy costs and slowing global economic growth (and hence demand for Japanese exports) are now taking their toll.

Japan's services sector, for example, bounced back slightly in March as consumers spent more to repair their cars, play golf and go to the theater. The tertiary index, which is a gauge of household and businesses spending on items ranging from phone calls, to power and transportation, increased 0.3 percent from February, the Trade Ministry said today in Tokyo, The uptick however followed a revised 1.6 percent decline in February, and as we can see from the chart below we are still below the level reached in January, and year on year the index is virtually unchanged.





Indeed tertiary demand, which accounts for about 60 percent of the economy, fell for the second consecutive quarter in the three months ended March 31, producing the first back-to-back decline since the economy emerged from a recession in 2002.



Evidence that households are cutting back on spending is now becoming pretty general and indeed household spending fell at the fastest pace in 15 months in March as prices of frequently purchased goods from milk to eggs climbed at an annual rate of 3.2 percent , more than double the growth in wages in that month.





Consumer confidence also dropped to a five- year low in April.





And consumers won't be able to count on higher paychecks to offset the impact of inflation because companies are unlikely to raise pay at a comparable rate as surging raw-material costs erode profit margins. In just one sign of the times example Japan Airlines announced last week that it was going to cut salaries and other benefits by 5 percent because profits are likely to drop 44.5 percent this year on fuel costs.

Meanwhile the Bank of Japan today kept interest rates on hold at their first meeting following a substantial reduction in their growth forecast. Today's meeeting was also of note since it marked the effective shelving of a two-year policy of seeking to raise interest rates.

``Japan's economic growth is slowing, mainly due to the effects of high energy and materials prices,'' the central bank said.

Exports rose at the slowest pace in almost three years in March.



At the same time production fell the most in at least five years in March.




The Bank of Japan dropped a call for gradual rate increases from its twice-yearly economic outlook published on April 30 and cut its estimate for this fiscal year's growth to 1.5 percent from 2.1 percent. It also forecast that consumer prices excluding fresh food will climb 1.1 percent, raising its inflation projection from 0.4 percent.

Over the last two years the economic outlook has consistently said that the bank would pursue higher interest rates, repeating the assertion that borrowing costs need to rise gradually as long as the economy keeps growing and prices remain stable. This has now been dropped but the report did retain a warning that continuing to keep rates at their current low levels could cause excessive investment and hamper growth in the long run.

Japan Economy Watchers and Consumer Confidence April 2008

Sentiment among Japanese merchants fell for the first time in three months in April as higher prices of daily necessities sapped consumers' spending power. The Economy Watchers index, a survey of barbers, taxi drivers and others who deal with consumers, dropped to 35.5 from 36.9 in March, the Cabinet Office said today in Tokyo. The outlook index of conditions in two to three months fell to 36.1.



Japan's consumer confidence also fell to its lowest in five years in April as gains in prices of everyday goods exceeded the pace of wage growth. The sentiment index dropped to 35.2 last month from 36.7 in March, the Cabinet Office said today in Tokyo, the lowest since March 2003.

``This depressing situation for consumers will continue until gains in food and oil stop eroding real income,'' said Takehiro Sato, chief economist at Morgan Stanley in Tokyo. ``It's very hard to paint an optimistic picture for consumer spending with this sluggish wage growth.''

Equipment orders, which signal capital spending in the next three to six months, declined 8.3 percent in March and companies expect orders to fall 10.3 percent in the second quarter, the Cabinet Office said yesterday.

Japan GDP Q1 2008

Japan’s economy accelerated slightly in the first three months of 2008, driven by exports to China and other emerging economies, turning in in the process the strongest quarter of export shipments in the last four years. Gross domestic product expanded at a seasonally adjusted annualised pace of 3.3 per cent, up from a revised 2.6 per cent pace in the fourth quarter, the cabinet office said in Tokyo on Friday.




From the previous quarter, the world’s second-largest economy grew 0.8 per cent, with net exports contributing 0.5 point to the growth. At the same time the government revised down its estimates for GDP growth in the fourth quarter of 2007 to a quarter-on-quarter rate of 0.6 percent, from 0.9 percent previously.





A rebound in housing investment and rising consumer spending also helped to ensure a third consecutive quarter of positive growth for Asia's largest economy. It is possible, however, that consumer spending has been helped somewhat by the fact that 2008 is a leap year, giving shoppers an extra day in February.

Consumer spending grew by 0.8 percent in the first quarter from the previous three months, while exports were up 4.5 percent, despite weakening demand in a US economy still labouring under a housing slump and a credit crunch.



Housing investment rose 4.6 percent, the first positive reading in five quarters. It followed a 9.2 percent fall in the fourth quarter, which was the biggest decline since April-June 1997 as the sector reeled from tighter building regulations implemented since last June.





As can be seen in the above chart, contruction had been virtually flat in Japan for some time before the sudden downward jolt last year. Some sort of recovery in the situation was only to be expected, but will this current surge be sustainable? If we look at new housing starts, we find they fell 15.6 per cent in March from a year earlier, significantly more than most analysts were expecting, so it is not at all clear that construction will continue to push upwards.



Corporate capital spending on the other hand fell by 0.9 percent as companies became less willing to invest in new factories and equipment amid an increasingly tough business climate.


Recent data showed Japan's exports to Asia rose 1.9 percent in March, the smallest increase since May 2005, as growth of shipments to China slowed to 3.2 percent from 14.9 percent, the slowest pace since June 2005.



The close association between exports and GDP quarterly growth can be seen in the following chart, where it is also clear that household consumption played a rather large part in Q1 2008 growth, the real question is why?

Inflation Returns to Japan - Tightroping Between a Slowdown and Recession

In this note, I am going to have a look at the recent slew of economic data for the month of March as well as other relevant information. Last time I did my monthly review of Japan the data had not budged much. This time is different. As per usual my analysis will progress by looking at Japan's economy from five angles which should subsequently yield a full picture of the current important yardsticks for assessing just where Japan might be heading. Consequently, I will have a look at price developments, domestic demand (also the labour market), domestic investment (and as a derivative here external demand) as well as the Yen. Immediately, there are two important questions which should be stated up front. One is whether I still see the BOJ cutting in Q2? I don't think so. As we shall see below derivatives trading implying future rate movements by the BOJ have, during the past month, moved from a dovish to hawkish and now back to a medium position where most investors and observers expect the BOJ to stay pat for the rest of 2008. The second question is whether Japan is heading for a recession. Upbeat data in the beginning of this month and the (most welcome) reluctance of the data to turn decidedly for the worse recently prompted Morgan Stanley's Takehiro Sato to somewhat retreat from his call that the global economy would see a dual-recession with the second unlucky economy being the US in this case. Since I have also been musing ominously about a potential recession in Japan am I about to retreat to? Not exactly, but I do concede that we are far, at this point, from an actual contraction in Japan. However, this also quickly turns into a alphabetic soup of just what kind of national accounts we are looking and how we 'deflate' the numbers. In Japan's case it e.g. depends on how we treat production vs. income. Basically, the current environment of stagflation means that traditional headline activity numbers need to be taken with a pinch of salt.

A lot of ground to cover then it seems. Let us commence.

If we begin with the development in prices the biggest news from the data was without a doubt how inflation has now returned to the shores of Japan. This was epitomized in the fact that even the price index stripped from food and energy managed to wring out a slight increase in prices at 0.1% y-o-y.

Yet, this is a far cry from the kind of 'escape' that was originally expected in the context of interest rate normalization in Japan and a positive spill-over effect as activity in the corporate sector as well as a tight labour market would lead to a recovery in Japan's hitherto slumbering domestic economy. Of course, the return of positive figures for Japanese inflation has prompted all kinds of knee-jerk reactions from commentators. Even the normally cool David Pilling from the FT was carried away I think as he featured a story noting how Japan may now finally have 'shaken' off more than a decade of deflation. I remain very skeptical of this and I completely agree with Edward when he says that the argument of Japan escaping deflation would carry much more weight if we were standing on the brink of a recovery rather than in the middle of the worst global financial crisis for many years, a subsequent slowdown in global trade, and a resulting slowdown in Japan's economic edifice. The fact consequently remains that the domestic economy is still slumbering and in this light the passage of strong headline inflation to core prices has not have been an easy one. Most commentators and observers are now beginning to latch on to the narrative I, among others, have been pushing in the context of how Japanese inflation is driven by cost-push rather than demand-pull inflation. Reports are thus coming in about how rising raw materials now represent a paramount risk to the Japanese economy. Ken Worsley furthermore has a timely analysis on the recent data from the inflation front reiterating the point that inflation is coming from all the 'wrong' sources. Japanese consumers are thus still very pessimistic on future income expectations and obviously the current bout of inflation naturally weighs heavily here since it erodes real income. We should also understand that the passage of prices down through the value chain is not occurring without collateral damage. This is the whole point about cost-push inflation without the subsequent demand effect. A significant sign of this came with the reports that the amount of small-cap companies, who constitute 70% of the Japanese workforce, filing for bankruptcies rose 18% in the year ending March. To be slain by the sword or the axe seems to be the nasty dilemma for many companies as they are finding themselves in a double bind with no real ability to pass on the rising costs over to their customers. The inflation figures above thus suggest that inflation is now finding its way to consumers in other goods than energy and food. This could in principle be a good sign in the sense that if inflation expectations were to persistently move upward it could pave the way for that much allured interest rate normalisation in Japan. Moreover, recent news that wages were climbing on the back of changing regulation prompting companies to regularize part time workers is a very welcome structural change in terms of labour market dynamics. Yet, I think it is unlikely that this constitutes a lingering trend or at least I remain skeptical that what we have now is the beginning of a virtuous circle. On the contrary it seems as if the current price dynamics in Japan could now constitute more of a vicious circle.

As for the immediate future the current momentum seems likely to keep all three inflation indices in the positive for the next couple of months. However, core prices in Tokyo for April actually moved from a 0.1% increase to a flat reading of 0%. Given that this figure is a leading indicator for the price indices above (to some extent at least) I would not be surprised to see a return to deflation for April in core prices.

If we move over to the development in domestic demand the situation is obviously closely related to the analysis of prices above. The first months of 2008 saw a surprisingly strong showing from Japanese consumers but as I also noted there might be a distortionary bias in the numbers. Quite simply, with a situation resembling stagflation (driven by price increases in food and energy) consumers cannot but take on the increase in prices in the context of consumption of 'non-luxury' goods (i.e. for which demand elasticity is low.)

The first figure above shows, as per usual, the main data as reported by the media. As can be observed the decline in y-o-y consumption of -1.6% means that the initial strong showing at the end of 2007 and in the beginning of 2008 now has been somewhat paired . In fact, the average of the last four months slots in nicely with my general rule of thumb that we should not expect domestic consumption to grow by more than 1% in a Japanese context. For a fuller analysis of this headline consumption figure Ken Worsley provides the relevant information. Especially, the sharp decline in durable goods (i.e. the lacking demand effect again) seems to be a decisive factor in explaining the March figure. A look at the more long term tendencies for the recent two months indicates that we are moving on nicely around reversion to a declining mean over time. The reason as to why we have a mean with 'trend' here as we put it in econometric lingo is, I think, to be found in the context of Japan's demographic profile where an ever declining size of the working and income earning cohorts relative to the total population coupled with endogenous changes in life cycle behaviour (at least I think so) exert a structural pressure on domestic consumption. The future cyclical tendencies in domestic consumption are very difficult to gauge I think. One thing which casts a cloud over the next months' reading is the flurry over the gasoline tax which was not re-approved by the DPJ and may thus be reinstated which would increase gasoline prices and thus potentially push up consumption expenditures (or even divert resources consequently pushing down consumption). The main point is that monthly consumption figures tend to be clouded in a stagflationary environment. What would perhaps be more pertinent, and Ken Worsley's analyses are usually very much to the point, is to look at traditional strong demand components such as durable goods, semi-durables, furniture etc (household investment), auto sales, etc. in order to gauge what the real domestic demand effect is.

In this way, and as I have recently emphasised it would serve us more to look at tendencies in corporate capex (e.g. industrial production) and its connection with export growth if we want to assess the Japanese business cycle.

As we see in the figure above it could seems as if the curve is starting to dip. Obviously, the interpretation for cyclical analysis is not straightforward since we are talking about an index but I still think it is beginning to look as a turning point. As Edward notes here industrial production also nudged back on a monthly basis which suggests that economic activity is now clearly firming down. Not surprisingly the relative poor showing from industrial production comes in conjunction with a marked slowdown in the increase of exports. The semantics here are not insignificant since what we need to understand is that absent a recovery in domestic demand Japan needs a high increase in the growth rate in both exports and as a derivative corporate capex in order to keep the economy floating. If this rate of increase slows down significantly (even if it may not dissipate entirely) it also effectively means an erosion of Japan's only shield against a severe slump. In this light specifically, IMF's and WTO's recent warnings of a significant slowdown in global trade are especially worrying from Japan's point of view since she so desperately depends on being able to leverage external hotpots of economic growth in order to keep growth at a minimum sustainable level*. If the slowdown stabilises on the current level of increase which is a bit lower than the high levels seen in the summer/autumn 2007 I think Japan can weather the storm without experiencing a contraction. However, if the slowdown in capex and exports intensify I am unsure as to how much we can expect domestic demand to take up the slack and in any case growth will have to come down to much lower levels.

Finally, I should mention FX markets where the Yen as ever remains an important canary in the coal mine for gauging the overall risk sentiment in the market place. For a more thorough operationalization of this argument I invite you visit my post on the USD/JPY and its correlation with equity markets.

As we can see the Yen has weakened across the board since last time we looked at this chart and even though we are not nearing the soothing pre credit turmoil carry trading days (save in the context of the EUR/JPY cross maybe) it does seem as if risky behavior is returning to the market. Now, as Macro Man notes in the comment section here he finds that this past week has been rather puzzling. This may be so. However, I don't think that our good MM's compass is completely off and in our immediate context he asked this Thursday whether in fact risky assets and carry trade were once again, if perhaps temporary, the game to play.

The SPX broke 1400 just before and after the FOMC announcement, but there was little appetite to follow through; the close must have been disappointing to bulls. Similarly, USD/JPY flirted heavily with resistance around 105 earlier in the day but failed to breach it, thanks in part to reported Golden Week offers from exporters. Watching these two charts in tandem is probably not a bad idea; if both break and hold, it should suggest that the risk trade is "on, baby." However, if they both continue to jiggly about without showing much inclination to break through, it will send a powerful signal that all is not well in Denmark.....or make that risky financial assets.

I completely agree with MM when he notes that we should be watching the USD/JPY in conjunction with the SP500. As such, it could seem as if the bulls were exiting their pens to scour the planes once again. Surely, those with a knack for risky assets could use the recent employment data from the US to underpin their views. Moreover, the USD seems to be staging somewhat of a come back against the Euro as the economy of the latter fiat currency now decisively seems to be heading for choppy waters. On the Yen, it remains calibrated as a very fine thermometer measuring the degree of risk aversion in financial markets. I urge investors in this context to remember that the fundamentals of Japan's economy are next to useless in plotting the path of the Yen and if anything exerts the opposite effect of what the textbooks would claim. Personally, I am surprised to see that the EUR/JPY is back in the +160 territory and from a short term tactical point of view I think that a sell could be warranted here. The USD/JPY is now firmly back in the 100s and we consequently never really got to stay for long in the <100s>

In Conclusion

How should we connect the threads there then? A good place to start would be to revisit the two questions stated in the beginning. Is Japan heading for a recession and pending that question what I am expecting from the BOJ? As regards the first question it is pretty difficult to say I think but what is not difficult to see is that Japan is now set to slow down significantly. Recently, the BOJ noted (see a detailed analysis here) how the economic outlook had worsened in eight out of nine regions. This change in outlook was chiefly driven by the adverse effect of high headline inflation as well as a decline in corporate profit. On the latter the BOJ is expecting that capex will trend down not least seen in the light of a general slowdown in global trade. The charts above support this analysis. The MOF (ministry of finance) also recently reiterated the general point that economic momentum is fading on the back of declining business activity and investment. I don't think this is surprising. However, what comes next will be a big test of what the idea of a recovery actually means in a Japanese context. Many observers have voiced the expectation that as the external economic edifice slows domestic demand would be able to take over the baton providing a cushion for the low levels of business investment as well as consumption would provide a buffer. I remain very skeptical with respect to these claims. At the very least I expect that whatever change of baton we will see the receiving athlete in the form of the Japanese consumer will be moving at a considerably slower pace than we have seen in the past 18 months. In that vein I think that industrial production need to be watched closely from here on, especially in connection with the slowdown in global trade. One important brigth spot in this regard is the reports indicating that companies are beginning to take on more full time employees as per function of recent legislation. We even learned from the data that unemployment declined in March. This could in theory give a structural boost to wages and thus domestic consumption. However, the chains of economic fundamentals have not been broken. A large bout of economic research suggests that the increase in part time jobs in connection with an ageing workforce is driven by productivity effects as well as ageing workers' preference for supplying their labor exclusively in a part time context. As such, wages should not be expected to increase above and beyond labour productivity I think since this is not possible in the context of many Japanese firms exposed to external competition.

Finally, we have the future course of the BOJ. The new governor Masaaki Shirakawa started out on a hawkish note which even had investors expecting a raise in interest rates at some point during the past month. Such expectations have now been paired and at this point we are back to "normal" so to speak with the BOJ in a perpetual holding position. In my mind there is no doubt that the proverbial statement paving the way for a cut in the event of a rapid deterioration of economic fundamentals is made . However, the market discourse has also changed so as to make a weary eye on climbing inflation a higher priority relative to the initial response of massive damage control to counter the effects of the credit turmoil. In this light I want to hammer down that Japan's exposure to the credit turmoil does not come from the liquidity issue itself but rather from the potential adverse effects of a general slowdown in global activity and trade. For the immediate future I am moving in behind the market consensus pointing towards a holding BOJ for the next three months. This position is subject to a revisit should industrial production show further signs of an accelerated slowdown.

*Where of course "sustainable" in the long run here is virtually impossible but if the end point can be postponed it can buy us time to perhaps turn the ship around

Japan Employment and Wages March 2008

Japan's wages rose for a third month in March as companies hired full-time workers at the fastest pace in almost 16 years. Total cash earnings, including overtime and bonuses, climbed 1.2 percent from a year earlier, the Labor Ministry said in Tokyo today.



In part this increase seems to reflect bonuses and overtime, since if we look at the real wage index this dropped back again at a minus 0.1 percent annual rate in March, after having undergone something of a recovery in January and February.



Wages have been rising this year as a labor regulation change prompts companies to promote their part-time workers to permanent status. As households face the fastest inflation in a decade, the gain in wages may not be enough to boost consumer spending, which accounts for more than half of the economy.

The number of those employed on a full-time basis rose 2.3 percent, the most since February 1993.

``The revised labor law is encouraging companies to hire full-time workers and is the main reason for wage growth,'' Yoshiki Shinke, a senior economist at Dai-Ichi Life Research Institute in Tokyo, said before the report. ``But it's not enough to encourage consumers to increase spending as gains in food and oil prices outpace wage growth.''

Under new rules for part-time workers, companies are urged to treat them as permanent staff for pay and other benefits. The law took effect last month. Hiring of full-time workers has been accelerating since October, while increases in part-time staff have been slowing.

Reports this week also showed household spending fell at the fastest pace since December 2006 in March and the number of jobs available to applicants fell to the lowest in almost three years. Overall household spending fell 1.6 per cent in March from a year earlier in price-adjusted real terms.






It is being suggested that the retirement of baby boomers is one of the major reasons companies want to secure full-time labor. The first of Japan's 7 million baby boomers reached the retirement age of 60 last year, according to Dai-Ichi Life Research Institute Inc., as a result employers are being left with an increasing number of positions to fill.


The Bank of Japan yesterday cut its economic growth forecast, saying the economy will grow 1.5 percent in the year ending March 31, down from the October estimate of 2.1 percent.