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Thursday, July 31, 2008

Japanese Wages Fall Again In June

Even nominal wages fell in June in Japan, the first time this year that this has happened. Falling nominal wages had been a commonplace with Japan's deflation, but now that we have some form of inflation back, then this is rather more surprising. Monthly wages, including overtime and bonuses, decreased 0.6 percent in June from a year earlier to 463,013 yen ($4,294), according to the latest data from the Labor Ministry. Bonuses fell 1.5 percent, the biggest drop since December. This connection with December is not entirely incidental since these are the months when large extra bonuses are paid. The fact that these are now significantly down even in nominal terms will evidently put noticeable pressure on household spending.

Prices of Japan's most frequently purchased goods rose 4.2 percent in June, prompting households to reduce spending for a fourth month. Sales at department stores were down 7.6 percent, the fastest pace in a decade, due to the rising prices of daily necessities, according to the Japan Department Store Association.

Real wages (ie corrected for inflation) were down annually by 2.9%, the third consecutive month of decline.

Wednesday, July 30, 2008

Japan Industrial Output Falls In June

Japan's industrial production fell back in June, the same month as exports declined for the first time in four years. Factory output was down 2 percent from May, when it rose 2.8 percent, according to the latest data from the Trade Ministry.

The Trade Ministry also lowered its assessment of industrial production, saying output is weakening after previously describing it as flat with signs of weakness. Companies plan to cut production 0.2 percent in July and 0.6 percent in August, the survey showed. The June drop completes two quarters of declining production, the first back-to-back contraction since 2001, when the country was in a recession.

Tuesday, July 29, 2008

Japanese Unemployment Rises In June Earnings Fall

Japan's seasonally adjusted unemployment rate rose to its highest level in almost two years in June adding to signs that the economy's longest postwar expansion may now finally be coming to an end. The June jobless rate climbed to 4.1 percent, according to the latest data from Japan's statistics bureau. Thi si the highest rate since September 2006.

The ratio of job offers available for each applicant slipped to 0.91, the lowest since February 2005. As compared with June 2007 there were 400,000 less people employed in June 2008. This last data`point is, perhaps, the clearest indicator of the deteriorating job market in Japan.

Spending by Japanese households also fell by 1.8 percent year on year in real terms - to an average 281,951 yen ($2,624.30) - in June. The most significant declines were in spending on housing renovations, clothing and food, according to the Ministry of Internal Affairs and Communications press release.

This was the fourth straight month of decline and followed a 3.2 percent drop
in May. The overall household income also fell 2.1 percent, with the income of
household heads down 4.1 percent. Extraordinary income - basically bonuses - fell
7.1 percent in June from a year earlier.

Before adjustment for inflation retail sales rose 0.3 percent in June from June 2007 as consumers found themselves having to pay more for petrol and food. When adjusted for inflation, sales slumped 3.3 percent, again the fourth consecutive monthly decline.

The Bank of Japan cut its assessment of the economy this month, stating that the economy was slowing "further" because of weak business investment and consumer spending. I think what we now need to see is the July export and industrial production data, and then we can more or less decide whether this is simply a one quarter contraction (Q2) or a full-blown recession with the contraction extending into Q3.

Friday, July 25, 2008

Japanese Consumer Price Rises Accelerate in June

Japan’s core consumer prices, which include energy and processed food, increased in June at the fastest rate since the Japan's lost decade-and-a-half began in 1992 - at least if we strip out the temporary spike caused by the effect of the consumption tax increase in 1997. The increase however came almost entirely from higher energy costs and food prices. Core prices, which exclude fruit, fish and vegetables, increased 1.9 percent from a year earlier after gaining 1.5 percent in May ,while "core-core" prices - excluding food and energy (and which provides a a measure of inflation similar to that used in, say, the U.S.) rose 0.1 percent in June from a year earlier. Thatis only the second time in the past 10 years that these prices have increased, but with the Japanese economy slowing rapidly, and recession seemingly on the horizon I wouldn't be holding out too much hope that this measure is going to stay in positive territory for very long.

Consumer confidence fell in June to the lowest level in at least 26 years because prices of daily necessities are rising faster than wages. Goods purchased at least 15 times a year climbed 4.2 percent in June, almost twice the pace of the previous month. Wages rose 0.8 percent in May. And as we saw yesterday Japanese exports shrank (y-o-y) for the first time in nearly five years in June as the growth in shipments to emerging markets that had underpinned demand failed to offset the global impact of the US and European economic slowdowns.

Thursday, July 24, 2008

As Exports Slow, Is Japan Recession Bound?

This is an interesting question, and my immediate response is yes, recession looks almost inevitable in Japan with exports folding the way they are in an economy where domestic consumption is unable to sustain growth.

Japan's exports fell year on year for the first time in more than four years in June (although they had been down month on month in both May and April, and ironically they were up in June over May) Exports decreased 1.7 percent in June 2007, according to the Finance Ministry this morning. The drop was the first since November 2003.

Exports to the U.S. were down by 15.4 percent year on year, and this was the 10th monthly drop and the biggest since November 2003. Shipments to Europe were down 11.2 percent, the second straight decline. Exports to China have been, more or less, holding up, and were up 5.1% on the year, although this is still down from a 12.2% rate of increase in May. Exports to Asia in general rose 1.5 percent, the slowest pace in two years.

Central banks across Asia have been raising interest rates to combat inflation, slowing economic growth and weakening demand for Japanese goods. Policy makers in the Philippines, Thailand and Indonesia all raised borrowing costs this month. It is quite possible that the Reserve Bank of India will increase rates again next week.

Exports to Vietnam rose at an annual 28.9%, down from its February peak of 88% (y-o-y), to India they were down to 19.3% from 40.1% in February, Brzil was down to 20.7% from 38.6% in February. Only exports to Indonesia (at 26.6% y-o-y) and Russia, at 39.4% (y-o-y) are really holding up, and these are, of course, oil exporters.

Imports on the other hand climbed 16.2 percent to a record because of the surging oil costs. That caused the trade surplus to shrink 89 percent to 138.6 billion yen ($1.3 billion). This will obviously have a negative impact on GDP growth.

My feeling is that with exports now falling y-o-y (they have already been falling m-o-m), and domestic consumption congenitally weak there is really now no way Japan can avoid recession (and my guess is that we are seeing the same thing in Germany).

The mechanics that did it are easy enough to identify. First there was the slowdown in the US, which Japan compensated for by growth in Europe as the dollar went down and the Euro went up, then there was the slowdown in Europe which was compensated for by growth in emerging markets in the CEE, while Japan leveraged growth in other parts of Asia. Then came inflation, monetary tightening and a decline in risk appetite, so now even the emerging markets are slowing, So down we all go, I guess.

Tuesday, July 15, 2008

Not Much News from the East

By Claus Vistesen Copenhagen

As predicted, the Bank of Japan ended its two day policy meeting with a holding operation. In its statement which, it has to be said, is relative brief the BOJ emphasised that significant downside is present with respect to the future course of domestic activity in the form of fixed capital formation and consumption. It was also interesting to note that the BOJ moved in with an indication that inflation pressures might abate in the coming months.

Economic growth is slowing further reflecting weaker growth in business fixed investment and private consumption against the backdrop of high energy and materials prices. While growth will likely remain slow for the time being, it is expected to gradually return onto a moderate growth path thereafter. CPI inflation rate (excluding fresh food) is currently around 1.5 percent due to increased prices of petroleum products and food. CPI inflation is expected to gradually moderate after becoming somewhat elevated in coming months. These suggest that the possibility of the economy remaining on a sustainable growth path with price stability is relatively high.

As Bloomberg's Mayumi Otsuma also latches on to it is the situation of stagflation lite which is pulling economic activity down. This was a theme I also noted in my recent in-depth look at Japan's economy. In general the risks for a raise in 2009 seems slim and as I noted recently it would take a marked and sustained increase in both core and headline inflation for this to materialise. Otsuma quotes research at JPMorgan Chase and Co. pointing towards a 13% chance/risk that the BOJ will raise come December.

Ultimately it looks like a solidified path of holding interest rates steady in Japan. In either direction it would take a sudden and large swing in fundamentals before the BOJ shifts its stance.

Friday, July 11, 2008

Japan Consumer Confidence Fall To Record Low In June 2008

Japanese consumers became more pessimistic than they have been at any tim in at least 26 years in June as higher energy prices and food costs steadily eroded their spending power. The Japanese Consumer Confidence Index dropped to 32.6 from 33.9 in May, according to data from the Japanese Cabinet Office earlier today. This the lowest reading registered since the government began compiling the figures in 1982.

Price rises for fuel and food have evidently badly dented the confidence of Japanese consumers, who after years of deflation had become accustomed to steady or slightly falling prices. Core consumer prices, which exclude those of fresh food but include energy, rose 1.5 percent in May, the biggest increase in 10 years.

Wages on the other hand have only grown lethargically, and were up a mere 0.2 percent in May, the slowest pace so far this year. The price of frequently purchased goods was up 2.4 percent in the same month, leading households to cut back spending at the fastest pace since September 2006.

The BOJ to Stand Pat

By Claus Vistesen Copenhagen

Monetary policy makers are often difficult to gauge, but looking forward to the BOJ meeting come next week (Monday and Tuesday) one thing seems fairly certain; the BOJ is going to hold off its guns yet again. That was also the conclusion reached by Bloomberg as they conducted a survey of 39 economists who unanimously called it a holding operation.

On the face of it the BOJ's dilemma is not so different from other central banks' in the sense that it is impossible to focus on growth and inflation at one and the same time. Yet, Japan is obviously a bit different since in this particular case there is the issue of continuing deflation in US style core prices while headline inflation is shooting up through the roof. For a visualization of the level form of price developments I can refer to my most recent assessment of the Japanese economy. What the graph below shows is the widening spread between the core-of-core price index (formally in deflation) and core price index.

It can easily be seen that this is not for the faint of heart and to make things worse wholesale inflation rose to a 27 year high in June. This suggests that a lot of inflation is creeping up through companies' supply and value chains. Now, there are arguments as to why we should not expect the link between wholesale and consumer prices to be particularly strong but it still confronts the BOJ with a set of quite un-welcome fundamentals.

In a slightly wider perspective it is quite interesting to witness the extent to which the BOJ's governing council under the charge of, the recently appointed, Masaaki Shirakawa basically has continued to tread the path laid out by Fukui. This would be the path then, on which extreme caution is exercised towards moving on rates in either direction. The interesting part of this is that Shirakawa was appointed as the main man of the BOJ, after a spectacle worthy to the annals of theatricals, in the expectation that he would hawkishly re-commence the very slow process of interest rate normalization in Japan. So far he and the rest of the council have been disappointing the hawks; that is, unless you take a whole new perspective of central bankers' propensity to gradualism.

In a more fundamental light the BOJ has simply recognized that the recovery is not on track and that the wisest road to take would be not to flog consumers (and companies) with increasing rates in the context of stagflation. More specifically, the ghost of deflation still lingers and I think it is safe to say that the BOJ is not inclined to risk increasing rates in order to combat inflation only to face the probability of re-introducing ZIRP. This would be a mirror image to the Bundesbank like attitude epitomized by the ECB and its recent preemptive move against inflation in a situation where the economic edifice is visibly crumbling. It is still too early to tell which of the global central banks that will emerge in the right. I think the BOJ is right not to push rates up but the current environment is not an easy one; that is for sure. Another thing which is making it a bit easier for the BOJ is the sudden abating of external pressures. In this way, it was only back in 2006 and beginning of 2007 that consecutive G8 meetings were ripe with comments to talk up the Yen and to push Japan to normalise rates more quickly. As a much welcome breather for the BOJ recent G8 meetings have not been concerned about the Yen but about the USD, the Fed's easing of monetary policy, and the inflationary nexus it represents as a result of USD pegging emerging markets.

One could however easily imagine the spotlight turning to Japan again at some point in the near future. In such a case and assuming that headline inflation continues to post accelerated increases it is not too difficult to see how the BOJ once again may be finding itself in a tight spot.

In the context of real economic fundamentals it is not very difficult to find ammunition for why the BOJ might want to hold off its plans to raise rates. I have an overview here as well as Edward provides additional pointers with his most recent write up on exports. The only bright spot was the impressive surge in machinery orders which provide pretty strong grounds for corporate capex in the immediate future. In a recent speech, governor Shirakawa also emphasised the risks to the economy. In particular, he made the following point in the context of terms of trade which is important to latch on to ...

"The deterioration in the terms of trade that results from rises in energy and materials prices leads to an outflow of real income, as Japan depends heavily on imported resources. This exerts downward pressure on corporate profits and reduces households' purchasing power. Although business fixed investment and private consumption remain firm, due attention should be paid to the possibility that the weakening of the economy's capacity to generate income will result in weaker domestic private demand."

Now, at this point I would be understanding if readers are a little bit confused. As such and if terms of trade deterioration is the main problem would it not make sense to raise rates to pump up the currency and thus increase the purchasing power? Perhaps ... but we should remember that this only works if demand responds appropriately. If it does not you might end up, in Japan's case, to push the domestic economy into deflation. Moreover and since Japan is highly dependent on exports to grow this is also a double edged sword since an increasing currency to mitigate terms of trade would also hurt companies' competitiveness; even if many would argue that the current value of the Yen would merit this.

On the specifics of monetary policy Shirakawa notes the reluctance of the BOJ to pre-commit;

"As I have explained, the outlook for economic activity and prices is highly uncertain at present. In this situation, the Bank considers that it is not appropriate to predetermine the direction of future monetary policy. Based on a thorough examination of the economic and price situation as well as the market situation both at home and abroad, the Bank will carefully assess the future outlook for economic activity and prices, closely considering the likelihood of its projections as well as relevant risk factors, and will implement its policies in a flexible manner."

This is basically central bank speak for "on hold" and would be very weary of calling a move either direction throughout the rest of 2008. For the chart hungry the BOJ's June report on the economic development is the place to go. It basically reiterates all the main points touched above. Japan will continue growing albeit at a slower pace which is going to be determined by the extent to which exports will continue to expand. Prices provide a risk but against the sharp backdrop of consumer spending and domestic activity this latter point is where the focus is.

The Perpetual Holding Position?

Anything short of cataclysmic events point towards the BOJ holding rates during the meeting next week. So, isn't this just the easiest job in the world being a BOJ watcher? At the moment it certainly seems to be quite an automatic exercise in terms of the direction of policy; quite simply there does not seem to be one which translates into a solidified holding operation. A couple of events however might wrestle the BOJ out of their current stance; in either direction.

  • One would be a return of inflation in core-of-core prices. I have argued (see links above) why I think this is unlikely but given that fact that the US style core index is running at "only" -0.1% it is not impossible to imagine a return to inflation. In such a scenario and given the current focus from investors and international policy makers on inflation it could prompt the BOJ to raise. I think however that it would take something in the region of three month's consecutive positive and increasing reading before such a move be considered.
  • Another event which could provide some action is a return of the focus on Japan as the main global liquidity anchor. This would be a return then to the days of 2006 and beginning of 2007 where Japan and its currency were the main talk of the town. If the economic fundamentals continue to deteriorate at the steady pace most analysts expect I have a hard time seeing the BOJ being bullied into raising rates. However, it would serve investors well to remember that what brought the BOJ to 0.5% in the first place was actually the very same pressure from G8 that I am suggesting will return. Edward Hugh's note at the time provides an excellent overview of the situation.
  • Finally, we should not dismiss the possibility that things take a turn for the worse and to such an extent that the BOJ be forced to lower rates, perhaps even reintroducing ZIRP. In a world where inflation is perceived the main culprit for the incoming economic ills such a move won't be easily wringed by the BOJ. One thing which could prompt such a scenario is the the solidification of deflation in core-of-core prices. As with the mirror situation described above I think it would take a marked deterioration in domestic inflation and demand dynamics before the BOJ considers this. At this point it is very difficult to gauge where the market discourse goes in the future. One could then easily imagine that fears of growth will return to the market in which case the BOJ's ability to sneak back into ZIRP will be eased.

Thursday, July 10, 2008

Japan Exports Slow and Current Account Surplus Drops in May 2008

Japan's current-account surplus narrowed for a third month in May as export growth slowed and record oil prices pushed up the import bill. The surplus shrank 5.9 percent to 2 trillion yen ($18.7 billion) from a year earlier, according to the latest data from the Ministry of Finance. Exports rose 4.2 percent in May from a year earlier, compared with 4.9 percent in April. Imports climbed 4 percent, compared with 13.4 percent in April. Month on month exports - at 6.805 trillion yen - were down on April (6.895 trillion yen).

Exports to the U.S. fell 9.5 percent and shipments to Europe slid 1.1 percent, the first drop since October 2005. Exports to Asia were up 8.1 percent from a year earlier, and those to China gained 12.3 percent, led by shipments of steel, automobiles and oil products. Japan's refiners sent extra fuel to China as part of relief efforts following the May 12 earthquake that killed more than 69,000 people.

Shipments to Russia, the world's biggest exporter of oil and gas, soared 58.8 percent year on year last month, while those to Vietnam were up 40.3%, to India 53.3%, Indonesia 30.4%, and Brazil 24.2%.

Wednesday, July 09, 2008

Uptick in New Machinery Orders In May

Well, nothing in economics is ever a one way street, and just to prove it orders for Japanese machinery rose at 10 times the pace most economists were expecting in May, as demand increased for equipment used to make semiconductors and steel. Machinery and equipment orders, which give some indication of likely capital spending in the next three to six months, rose 10.4 percent from April when they were up 5.5 percent, according to the Cabinet Office this morning.

Orders from the steel industry surged 131 percent, and for electrical machinery climbed 34 percent while demand for equipment used to make cars fell 3.3 percent. Today's reading can be seen tpo some extent as a reaction to declines in February and March, when orders dropped 12.3 percent and 8.3 percent, but the profit squeeze caused by higher oil costs without real price leverage may well prompt companies to once more cut spending in the coming months.

Overseas orders were up 21.1% from a 4.6% rate of increase in April. This may indicate that June exports could "bounce up" a little bit.

Tuesday, July 08, 2008

The Japan Economy Watchers Index Falls Again In June

by Edward Hugh: Barcelona

The Economy Watchers index - a survey of barbers, taxi drivers and others who serve the general public directly was down again in June, falling to 29.5 (a six year low)from 32.1 in May, according to data from the Cabinet Office today. The forward looking index for conditions in two to three months time slid to 32.1, its worst reading since September 2001 (down from 35.1. in May).

Obviously the combination of rising food and energy prices and pressure on wages is now hitting people. A record 88.9 percent of those interviews expected prices to rise over the next 12 months according to last week's Bank of Japan survey, while an unprecedented 58.7 percent said they were going to cut spending. Again this is not particularly surprising since the latest data show that wages only were up 0.2 percent year on year in May, while the prices of the most frequently purchased products grew 2.4 percent.

Sunday, July 06, 2008

Japan - Still Fighting off the Recession; When Will the Strength Ebb Out?

By Claus Vistesen Copenhagen

Japan is still hanging on it seems, but for how long? This is what I will try to clarify in this entry. In the following I will thus continue my ongoing analysis on two months' worth of data as well as loads of timely analysis from other sources where, as usual, Ken Worsley and Takehiro Sato/Feldman from Morgan Stanley have my complete attention. In accordance with tradition four overall themes will form the backbone of the analysis; trends in prices, domestic demand figures, industrial output/exports, and finally the JPY which as ever is the subject of much attention in currency markets and beyond.

When it comes to prices it could seem as if Japan's quick return to inflation in the core-of-core index was nothing more than a blip. As can consequently be observed from the graph below Japan is once again stuck in deflation measured by the core index stripped of energy and food input; both April and May thus saw a decline in US style core prices of -0.1%.

The graph above also recounts the story of global stagflation with Japan as perspective. Thus, while core-of-core inflation remains in deflation the core general inflation index has shot up on the back of global headline inflation pressures. As will be described below this is obviously having a non-negliable effect on an already lackluster Japanese consumer. More generally, I have been emphasizing this chasm between core and headline inflation for quite some time as well as I have been pointing out that inflation in Japan was solely of a cost-push nature rather than demand-pull.

Indeed, the whole discussion of "spill-over effects" in Japan and how activity in one part of the economy (corporate capex/exports) would automatically lead to an increase in domestic demand seems now to have finally been laid to rest. This is a welcome structural break in the discourse as pundits and analysts have been waiting for these positive spill-over effects ever since the BOJ chose to end ZIRP back in 2006. So far this exercise is almost remnisient of that famous play by Samuel Beckett. A clear sign that a structural break has occurred in the analytical discourse comes from the recent writings by Morgan Stanley's Takehiro Sato and not least this specific note in which he splendidly argues the case that headline inflation pressures won't necessarily spill over into core inflation.

The idea that cost-push inflation can lead to a reflation story appears to rest on the belief that expanding corporate margins fed by price hikes can allow depressed real wage levels to recover. However, for non-durable goods we cannot expect a powerful volume boost from a consumption spurt even if prices rise, and if sales volumes are slumping corporate earnings would presumably come under pressure. The household survey data for January-March in fact show that real expenditure on items for which prices have risen (mayonnaise, canned seafood, bread, instant noodles) fell across the board.

I would be hard pressed to deliver the argument more succinctly. There are two important points here. First of all we have the point that no matter how far up those mayonnaise prices have to go it won't likely lead to front loading of expenditures. I completely agree with Sato when he argues that rising food and energy prices won't lead to hoarding (well, gas perhaps but that is hazardous). In fact, and if my readers will dare venture back to econ 101 (if possible) the cross-price elasticity of such products with respect to other goods/services will be high meaning that as headline inflation graps hold demand for these will fall. This is especially the case when real income growth is flat trending to negative.

However, cost-push inflation as a concept is not of course limited to headline inflation. This brings us to the second point. It is by now well known that input/wholesale prices are rising across the board in Japan but while these pressures are finding the consumer in the form of elevated energy and food prices it is not, to any significant degree, finding its way to consumers in the form of goods such as durables, textiles etc. This tells us an important story about the price and demand dynamics in Japan. As Robert Alan Feldman put it at some point; there is something funny about Japanese consumption. This "funny feeling", if you will forgive me my pun, has something to do with the demographics of Japan and how the capacity for mustering demand pull inflation is simply not there to any significant extent. This also finally means that inflation pressures will have a tendency to clog up in the value chain as companies find it difficult to pass on wholesale price increases to consumers, and the extent to which they do; it will have a very direct impact on consumption figures.

Speaking of which it seems that the Japanese consumer has now finally succumbed to the pressures of headline inflation rolling in over the shores of Japan. The visual inspection tells a clear story then.

The Japanese consumer put in an unexpectedly strong showing in the first months of 2008 which was also a contributing factor in presenting a more than respectable Q1 GDP figure (although exports as ever accounted for the lion's share). In April and May consumption however accelerated its decline with -2.7% and -3.2% y-o-y respectively. Anything short of a veritable summer shopping frenzy in June will mean that consumption is likely to be a significant drag on GDP in Q2. As per usual Ken Worsley is watching incoming consumption data like a hawk. Judged by his account especially May seem to have been a tough month for Japanese retailers et al. Further snippets provide break downs in terms of supermarket sales which fell 1.1% in May as well as nationwide department store sales falling 2.7%. Japanese consumers are quite literally cutting back across the board, both in terms of spending on food and gasoline but also in terms of services. Spending on durable goods rose in May after three months of consecutive decline.

In terms of the outlook it seems as if consumer confidence in Japan can only go one way at the moment. With an index running at 33.9 points it stands at a five time lows close to the all time low marked in 2001 at 33 points. The plight of the Japanese consumer is understandable but also worrying. It is understandable because the current bout of stagflation is sure to pinch consumers across the global economic edifice but the speed and rate of pessimism and drop in real activity is quite severe in Japan. In terms of overall demand dynamics it tells an important story about the ability of Japan to shield itself from what comes next in terms of a slowdown in exports and industrial production. One thing is sure in this regard. Even if Japanese employers increasingly are beginning to convert part time workers into full time workers the increase in wages cannot, and not by a long shot, keep up with the pace of headline inflation pressures.

Turning to the corporate sector and thus the important data point of industrial production Japanese companies surprised us with a strong showing in May. For good measure the graph below does not include May figures as the index I track for these analyses lag the one reported by Edward linked above.

The graph is still instructive I think. Industry activity as a whole is now decisively situated on one of those famous plateaus. Moreover, the tendency seems to be one of decline. The important point here is not that industrial production and corporate capex will plummet but more so that the very impressive readings from the latter part of 2007 will be replaced by a more moderate growth clip. In a Japanese context this is significant since the nexus of industrial production and exports is so vital to keep the economy from stagnation or outright recession.

As with the consumption sector the outlook for corporate activity is increasingly looking weaker by the day. Business confidence declined to the lowest in four years on the back of surging commodity tests. Moreover, the widely watched Tankan survey for June, see Takehiro Sato for preview and background, confirmed that momentum is winding down significantly in Japan's industrial sector. Especially companies' expectations of profits deteriorated markedly with companies expecting profits to decline 7% in the coming quarter (Q3).

Yet, not only from an accounting perspective are Japanese companies beginning to sail into dire straits. Judged by the recent performance of Japanese equities the extent of downsizing in terms of value destruction/discounting is quite extensive.

It should be immediately noted of course that global equities in general seem to be facing much more lackluster times having decisively left the bull pen to go into the woods searching for the bear. However, the recent days' performance of the Nikkei 225 are breaking all kinds of scary records. Interestingly and as an important differentiation to the whole debate on decoupling it seems as especially the incoming slowdown in emerging markets (China and India) is having an effect.

In essence, it seems as if Japanese companies, like the consumer, are getting pinched at the moment. If global momentum continues to deteriorate we should expect headline industrial capex figures to exhibit considerable relative weakness in the months and quarters to come.

On a more structural note and even though it is formally unrelated I could not help but feel vindicated by the recent news from the political scene that the government is considering a tax cut aimed at companies to boost their competitiveness. Now, whenever the debate on fiscal policy in Japan homes in on tax cuts it is sure to send shivers down the backs of officials in the ministry of finance. As such, with a debt/gdp ratio running at about 170% you don't just dole out tax cuts without having a plan to raise taxes in another place. And if you do, those feathers provided by recent debt rating upgrades may soon be ruffled.

In other words, we are talking about the fine art of redistributive policy. In this specific context I got that familiar feeling of deja-vu when it transpired from Bloomberg's report that the government would, or was contemplating to, finance tax cuts by imposing sales and income taxes. It is of course never that simple, and while Japan's government may simply be responding to sound advice from the OECD this discourse of easing the tax burden for companies by tightening fiscal policy in the context of consumers is not new in Japan.

It is important to understand then that the extent to which consumption is taxed as a way to ease conditions of companies will only solidify the growth path onto which Japan is now situated. I don't believe that this is a question of one or the other but I do think it is important that policy makers (and investors) are aware of the consequences. Whether the lowering of corporate tax rates will lead to a marked increase in FDI is debatable I think. The channel by which such investments would flow to Japan would not, I think, be based on the exploitation of a buoyant domestic market. However, if Japan can succeed (and in many ways this is a fait accomplit) in becoming one of the main links to the Indian and Chinese growth history, FDI could be expected to come in on this account. This would then be the kind of FDI which promotes export activities.

Shifting gears and turning to the external sector and the JPY a couple of interesting developments have emerged since we last convened. In a world of (largely) free flows of capital it is only natural that the currency of the third biggest economy commands much attention not least because of the extraordinarily low relative yield (0.5%) it carries. Below is a chart of the major Yen crosses as an index with the beginning of 2006 as the initial value (100).

It can easily be observed how the JPY depreciated steadily up until August 2007 after which the credit turmoil grabbed hold. Especially the USD/JPY has seen its value spike due to a depreciation of the USD but also the NZD/JPY has seen a correction. As regards the JPY (and to some extent the CHF as the other "low-yielder") there are two major themes for investors to watch out for; both of which I have elaborated on extensively. To distinguish between the two it is fruitful to think of one representing fundamentals and one representing market sentiment.

The latter theme is well known by market participants and FX punters; in the context of my own analysis I even made a paper out of it which shows how JPY and CHF crosses, since the credit turmoil, have acted as very finely tuned risk sentiment gauges in the market place. This was epitomized by the spring market action where turmoil surrounding Bear Sterns and other juicy events brought the Yen as high as to 95 to the USD on the back of "perceived" unwinding of carry trade positions. More specifically, I also show in my paper that the negative relationship between low-yielding currencies and risk (as measure by stock market indices) is very fine tuned indeed even to such an extent that the negative correlation can be tracked on a daily return basis. Yet, correlations rarely hold over an indefinite time span and one should at least expect correlations to exhibit variations in terms of strength. This is certainly true with the correlation noted above as we saw recently how the correlation between the USD/JPY and SP500 broke out of range.

This brings us to the second theme and one which we could then label fundamentals. Under this narrative lies the fact that with an interest rate of 0.5% as well as an economy characterised by export dependence money will have a strong propensity to flow out in search for yield. Such a process and subsequent decline in home bias will also quite naturally put an effective floor for the appreciation of the domestic currency. In fact, over time one would expect the currency to depreciate steadily on the back of such outflows. Various versions of carry trade will have the same effect of course.

As always there is a demand as well as a supply side here. The interesting thing is that it is difficult to see just where one begins and the other ends. One narration of the market would then be to see Japanese savers as the demand side and the rest of the world's yield as supply. This theme which encapsulates the need for an ageing economy to earn asset income from outside its borders to fuel growth (export dependence remember) was described in my recent post on how Japanese savings are going for yield. Another way would be to turn the tables and narrate the pool of Japanese savings as the supply side and foreign investors not to mention asset managers as the demand side. In this way, an abundance of capital and a 0.5% interest rate provide strong incentive for asset managers and companies to seek out funds in Japan. The surge in the sale of samurai bonds would be a case in point here.

Whatever way we choose to look at this it is imperative that investors and analysts alike consider both the effects cited above. As for immediate forecasts on the JPY, there seems to have been a structural break. It appears then that the recent turn for worse in equity markets have not prompted the JPY to hurry back towards Spring's high levels. In stead, the fundamental story is taking over as forecasters across the board are now predicting the USD/JPY to move towards 115 which interesting was about the same value I marked out for 2008. Up until this point the risk sentiment argument seemed to have thoroughly proven me wrong but now it is perhaps time to pull out the idea of a USD/JPY back in pre-credit turmoil 115-120s?

End of the Line for Japan?

How to connect the dots then? In the text above I mention the Samuel Beckett and his existentialist play Waiting for Godot in which Estragon and Vladimir attempts to pass time as they wait for Godot to arrive. Quite a tough one to sit out in the theater I have to say, and so has it been with my continuing recession call for Japan. It is certain then that the GDP performance churned out in Q4 07 and Q1 08 have resembled anything but recession. Yet, Japanese GDP figures are notoriously volatile (and thus inconclusive in the big picture) whereas indicators such as industrial production are more solid.

More generally, as Edward put it recently indicators from the Japanese economy are now showing weakness everywhere. In this framework it is difficult to escape the fact that Japan, if not heading for one, will be flirting with recession in the quarters to come. I am not pulling this out of thin air either. Leafing through the analyses by Japan watchers will also confirm that the R-word is being used with more regularity than only a months ago. What is significant I think is that the Japanese consumer now decisively seems to have thrown in the towel suffering under the yoke of stagflation. What remains is then corporate capex/industrial production which should not contract as such but grow at a much slower pace. This need not push Japan into a recession but it definitely means that momentum is heading down.

As regards monetary policy I think I need to devote a separate piece to really get down to business. However, and while many expected the new governor Masaaki Shirakawa to be of the hawkish pedigree he has so far not been able to steer the BOJ away from its perpetual holding position. The BOJ will not, it seems, lift rates as long as core-of-core prices are in negative territory and to the other side the situation is not deemed seriously enough to re-introduce ZIRP. This latter option would also most definitely test the newly found G8 stance against inflation and at this point I think the BOJ is quite happy staying out of the limelight.

I dare not call it a recession in Japan just yet but I will say that the signs are mounting that Q2 will mark a structural break in headline GDP figures for Japan. The key as always is industrial production and exports and the extent to which activity can be kept at a pace to compensate the obvious slump in domestic demand.

Tuesday, July 01, 2008

Japan Wages May 2008 and the June Tankan

Japan's wages grew at the slowest pace in five months in May, suggesting that households will continue to reduce spending as inflation rises faster than workers' paychecks. Monthly wages, including overtime and bonuses, climbed 0.2 percent from a year earlier to 275,815 yen, according to the Japanese Labor Ministry. Due to the impact of inflation this becomes a 1.2% fall in real terms.

Households cut back their spending at the fastest pace since September 2006 in May, as inflation surged to a decade high. A weakening job market has also helped push consumer sentiment to a six-year low as consumers face higher energy and food prices.

Manufacturers worked fewer hours in the month, which reduced their overtime pay and the overall wage figure, according to Shunichi Ando, head of the Labor Ministry's statistics division. Overtime hours at manufacturers fell 3.9 percent in May, not far from the 4.1 percent drop in April, the biggest decline in six years.

The full-time workforce grew by 1.7 percent, slower than April's 2 percent increase, while the number of part-timers was up 1.7 percent from 1.2 percent in April. Slowing factory output prompted the government to downgrade its assessment of production for the first time in six months in May. Industrial production fell in March and April.

The Tankan index of manufacturer sentiment which was also published this morning confirmed this general negative impression, with the idex sliding to 5 points in June from 11 in March. This was a third quarterly decline, the Bank of Japan said today in Tokyo. Large companies forecast profits would drop 7 percent in the year ending March 31, compared with a 0.3 percent increase predicted three months ago.

The yen traded at 106.10 per dollar as of 12:40 p.m. in Tokyo from 106.15 before the report. Japan's currency has now weakened 4 percent against the dollar since the previous Tankan on April 1.