Playing the Waiting Game in Japan

(cross-post from Alpha.Sources)

As I reported a couple of days ago on Japan the next few days would see the release of a slew of economic indicators pointing forward to the future course from the BOJ in Q3 and Q4 (with the nature of the just released data I find it very unlikely that the BOJ will jump-start markets with a surprise raise in July). These 'few days' have now passed and we can now do some kind of status. I managed to slip in, as an update, the report on industrial production in my post linked above. Generally, the result was disappointing from the point of view of expectations and given the trajectory of the numbers (see graph by Edward here) I noted the following;

Now, the interesting thing is I think that it could look as if the Q4 2006 capex bonanza could take almost two thirds of 2007 to unwind, especially if the the US economy continues to 'under perform.' If this is the case, the data on domestic consumption will be very important indeed.

To respond to that we might want to check out the recent data on consumption in May (Bloomberg article on both the latest CPI release and consumption expenditures). As reported, household consumption rose 0.4% on a y-o-y basis which indeed extends the increasing throughout 2007 up until May. Yet, 0.4% is not much and compared to last month it marks a relative decline compared to April of 0.7%. In this way I will stick to my prediction stating that despite what many are calling the revival of domestic consumption in Japan it is unlikely that we will push above the 1% threshold on an average y-o-y basis. This goes especially if we use seasonally adjusted data as our primary gauge. The figure below plots monthly changes on a y-o-y basis in consumption expenditures since May 2006.

Turning to inflation prices held steady in May posting a 0.1% decline y-o-y which was the same as the previous month, so Japan is still in deflation it seems. Another somewhat important data point was the inflation figures (core prices) from Tokyo which posted a 0.1% decline in June, its first slide in three months. This does not bode well for nationwide inflation figures in June. The graph below plots (according to the tale of the three inflations) inflation in Japan on a y-o-y basis from May 2006 to May 2007.

So, what does all this mean? First of all I think it has cast serious doubts on the future course from the BOJ. Clearly, the July surprise hike which has been much debated is out of the question I think. Another thing which is politically related is the fact that Fukui is set to step down in March next year. Clearly, he wants to leave the best possible kind of conditions for his successor; the question obviously remains then, will that make him/the BOJ more or less hawkish? A hike in August or September cannot be ruled out just yet I think and much will depend, I think, on the continuous tightening of the labour market (unemployment is stable at 3.8% in May) and whether this will have an inflationary effect. Furthermore, there is of course the headline inflation rate which is set, after a dip in the latter part of 2006, to continue its structural upward trend. Turning to international FX markets the show thus seems set to go on with the Yen reaching new lows fuelling sizzling growth in among other countries New Zealand where a refi rate of 8% is acting like an over dimensioned Yen magnet. I don't condone complacency but at this point and with the current relative benign global economic conditions not pushing up inflation in Japan it is just completely impossible for me to see how the BOJ ever will be able to close the gap to a degree which would make the carry trade unwind. In fact as I have noted before, I believe it is more likely that any narrowing of the interest differential between Japan and the rest of the world will come through the lowering of interest rates elsewhere.

Japan Industrial Production

The latest data on Japanese industrial production have raised some eyebrows. Below I am putting up a quick excel chart of manufacturing and mining output on a monthly basis since April 2006 I have just knocked out. (The raw data can be accessed from here).




The trend should be reasonably clear, and certainly the recent wave seems to have peaked back in December last year. Of course, as Claus was pointing out yesterday not everything is gloom at the moment. But the situation is complex, and for the time being we simply need to keep monitoring the data. It is however hard to envisage a rapid interest tightening process in this environment (especially when you look at this recent US durable goods release).

Japan’s industrial production unexpectedly fell in May from a month earlier, casting doubt on an anticipated rebound in output and raising the hurdle for the Bank of Japan to raise rates in the coming months. Industrial output fell 0.4 per cent in May from April, government data showed on Thursday, much weaker than a median market forecast for a 0.8 per cent rise and marking the third straight month of decline.

The weaker-than-expected reading hurt the yen, which slipped to near 123.35 to the dollar from 123.20.

Manufacturers’ output – the core component of production – is expected to rise 1.9 per cent in June and rise 1.7 per cent in July, the data from the Ministry of Economy, Trade and Industry showed.

Still, the ministry downgraded its view on output, saying it is flattening. That compared with the previous month’s assessment that output was in a moderately rising trend.

Industrial production fell in January-March for the first time in six quarters, but many economists thought the drop was a reaction to a sharp rise in October-December and that output would rebound in April-June.

The May output data may call such thinking into question and heighten worries over Japan’s corporate-sector strength.

Tokyo real estate still too expensive

Burbed came up with this link:

Japanese find sleep, shelter in cyber cafes

Men make use of the internet service in the private rooms of an internet cafe in Tokyo May 2, 2007. Some low-wage earning young people who cannot afford apartments in Tokyo are choosing to live in internet cafes, which are cheaper than a hotel and even offer showers, microwaves and large libraries of manga to read. Picture taken May 2, 2007. (Kim Kyung-Hoon/Reuters)

Cross post from Wasatch Economics...

Where There is Hope ...

Cross-post from Alpha.Sources

Small things matter in terms of the Japanese economy and especially when it comes to the indicators for domestic demand and inflation. As such, the next couple of days will see important releases on the Japanese economy which, according to the forecasts, are going to come out on the positive side thus further bolstering the BOJ towards a potential hike in August or September. The first data point which suggests this comes from the figures for retail sales in May which rose an almight 0.1% from a year earlier and 0.3% from a month earlier. Now, as Bloomberg never tires of pointing out, retail sales tend to understate domestic consumption in Japan since it excludes purchases over the interenet as well as services. Particularly the latter is important in Japan. On the other hand, the trade ministry also noted a strong seasonal component in this reading as especially warm weather added to the increase through food and beverage sales. All in all though, past experience suggest that these retail figures should provide a solid ground for a positive monthly reading of domestic consumption in May. On the inflation front there is no data out until the 29th but already now there seems to be grounds for 'optimism', at least given Bloomberg's compiled forecast which note that the decline in consumer prices probably stayed at -0.1 in May. Anonther measure of inflation which also shows signs of an upward tick in the indirect measures of inflation such as producer prices and whole sale prices. However, do note this ...

Higher costs of energy and raw materials are driving up Japan's wholesale prices of goods as well as services. Producer prices climbed 2.2 percent in May from a year earlier, a 39th month of gains.

The central bank's overseas commodity index of 16 raw materials, including crude oil and copper, climbed 3.7 percent in May from a year earlier, a fourth monthly gain.

Inflation of course is inflation and this is particularly the case in Japan where the headline inflation is lumped together with the more traditional core inflation index (core of core) and then there is also company service prices which rose, so some upward pressure is clear there ...

Faster growth in the costs companies pay for services such as transportation and rent may prompt them to raise prices, sparking inflation. Central bank Governor Toshihiko Fukui has said consumer prices, which fell in April for a third month, will rise over the long term.

The big question still remains I think whether this is because activity in Japan's domestic market is picking up the pace to any significant degree. Finally in terms of economic indicators we should also be looking out for factory output figures which are released tomorrow. As with inflation the forecasts are fairly bullish and more importantly, as quoted by Bloomberg, this report will be an important indicator as to the future course of the BOJ in terms of raising in August or September.

As another almost regular sequence in my notes on Japan I feel the need to refer to Morgan Stanley's Takehiro Sato who also has note up on the outlook on the Japanese economy. One of the most notable things to watch out for in Sato's analysis is his account of why wage pressures in Japan are still somewhat distant even if we take into account that the labour market is very tight. Note particularly the structural factors in terms of part-time workers and how the wage curve remains tilted towards elderly workers. Add to this, Japan's continuous demographic decline which will only intensify (save potential migration) over the next couple of years it is difficult to see how wages can be pushed up to support consumption. In this way and although this might appear to represent the same capacity issues in for example Latvia compared to Japan are very different. As such, the rapid wage inflation spiral which are now seeing in Latvia as a result of an ultra tight labour market is very different from Japan where it is predominantly the relatively sluggish domestic demand component on the back of the high median age that are holding down inflation. In this way it is difficult to see how Japan, with its current growth rate in domestic demand in the middle of this very impressive global growth spurt, would be able to sustain the kind of inflation expectations we would normally expect in this kind of labour market environment. This of course is even more true if we factor in the BOJ which is clearly biased towards raising on the back of 'future' inflation expectations. My worry as it has always principally been with Japan is that this is like preparing for a party to which the guests will never arrive.