BearBull Group Research: Falling Yen Will Push BOJ Into Action
BearBull Global Investments Group (DIFC)
BearBull Global Investments Group is a leading independent Swiss wealth advisory firm based in the DIFC
Key Points:
New contraction in the Japanese economy
Our forecast of negative GDP growth for Japan is now more evident in light of the first quarter 2024 GDP results and recent developments for the second quarter. Preliminary data for the first quarter shows Japan's economy contracting by -0.5%. This decline continues from the previous quarter, driven by persistently weak international demand and sluggish domestic consumption. The -0.5% quarterly figure translates to an annualized contraction of -1.8%, significantly below consensus expectations of -1.2%. Private consumption remains notably weak (-0.7%), marking the fourth consecutive quarter of decline and weighing heavily on Japan's economic performance. Meanwhile, businesses reduced their spending (-0.4%), with a slight boost from inventory growth (+0.3%) offset by net exports (-0.4%), which acted as a drag on growth. The persistent weakness in consumption remains a critical issue for Japan and a real source of concern, with current economic momentum largely reliant on public expenditures.
Japan continues to face significant challenges since summer 2023 and has been unable to emerge from this increasingly pronounced slowdown, ultimately pushing the country's economy into recession.
The recent underperformance of Japan over the past quarters has also had a damaging impact on its global economic ranking. Due to the decline in Japanese GDP, the country has been relegated to fourth place, surpassed by the German economy which now ranks third. The yen's exchange rate dropped by 6% in the second quarter, marking a total depreciation of approximately 14% in 2024. However, this yen depreciation has not significantly boosted the country's exports, indicating that global demand remains particularly weak and is therefore not logically stimulated by the yen's decline.
Possible improvement in the third quarter
The Japanese GDP remains more dependent than ever on international demand, while domestic consumption continues to struggle to recover. The economy is weakened by sluggish household consumption and exports that are entirely tied to the international economic environment. Household consumption continues to be adversely affected by persistent inflation, which has little chance of decreasing rapidly in the current context.
The depreciation of the yen exacerbates the risks of imported deflation, posing a dilemma for the central bank, which cannot effectively combat inflation by tightening monetary policy without further plunging the economy into recession. With declining purchasing power due to persistent inflation and stagnant consumer income, stabilization can only occur very gradually. Consumer spending is consequently subdued and not easily stimulated. Consumers have increasingly used their income to maintain consumption levels since the Covid crisis, as evidenced by the sharp drop in the quarterly savings ratio from 20% during Covid to -0.3% by the end of 2023. As of 2024, Japanese households on average are no longer able to save. This extreme situation has only occurred once before during the 2013-2014 period, underscoring the severity of Japanese household finances. The same hesitancy applies to businesses, which are reluctant to undertake new investments. Japan now more than ever appears to need a global demand recovery, particularly an economic revival in China, to counterbalance weakening domestic demand. However, this shift in Chinese dynamics has struggled to materialize despite supportive measures by the Chinese government. With global demand slowing and some European countries battling recession risks, a strong potential rebound in international demand and domestic consumption is not anticipated in the short term. Growth in the second quarter is expected to remain weak, though it could still marginally stay positive.
New hesitations from leading indicators
The Jibun Bank of Japan's manufacturing leading indicators had returned to positive territory in May following a strong recovery during the spring, rising from 47.2 to 50.4, once again above the growth threshold. However, June's figure shows a renewed downturn in outlooks and a return of uncertainties, with the indicator barely above the growth threshold at 50.1. The services indicator reveals a much more concerning trend, as after being the primary source of recovery hope throughout 2023 and until May, it sharply declined in June from 53.8 to 49.8, dropping below the 50 level to reach its lowest point since July 2022. Therefore, the prospects indicated by the composite indicator have significantly darkened with its decline from 52.6 to just 50.
The activity measured by the Ministry of Economy and Trade in the tertiary sector showed a somewhat more optimistic picture a few weeks ago, at a time when industrial production also seemed to be gradually recovering from a less negative situation, despite a year-on-year decline of -1.8% in April. The Japanese economy is feeling the effects of global slowdown, not only in its declining industrial production but also in machine tool orders, which continue to be greatly affected by international slowdown. However, comparing over twelve months shows an improvement as orders are now up by +4.2%, following a low point in January this year (-14%). This improvement is mainly due to a strong recovery in Chinese orders (+19%) in May, following several periods of severe contraction.
Japanese export growth significantly improved in May, reaching +13.5%. Just six months ago, exports were stagnant year-on-year. The +11.9% annual growth in Japanese exports for January contrasts significantly with previous observations. These results surprised observers and were facilitated by a weaker yen, leading to a +23.9% increase in exports to the United States, +17.8% to China, while contracting by -10.1% with Europe.
Household consumption showing mixed results
Household spending weakness had weighed on GDP growth in the first quarter, but it appears to have slightly rebounded in April (+0.5%), possibly halting, albeit temporarily, a fourteen-month contraction streak. Nominal wage growth has improved marginally, but it remains insufficient to offset inflation, resulting in real wage declines persisting for two years. Household consumption could still strengthen due to another factor influencing consumer confidence: government tax rebates aimed at boosting disposable income and supporting consumption. However, consumer confidence indicators have unexpectedly turned negative over the past two months in response to expected inflation and price developments, despite a robust job market. The absence of a significant inflation decrease continues to heavily impact consumer sentiment, and the yen's depreciation by -14% since the beginning of the year is unlikely to ease anticipated price declines.
Yen depreciation revives imported inflation
We are now far from the deflationary measures seen in January 2024, which were then seen as a positive surprise for Japanese consumers. The national price index rebounded from +2.2% to +2.8%, while the year-on-year CPI drop for Tokyo from +2.4% to just +1.6% in January gave way to a significant rebound to +2.2% in May.
While overall indices have shown new pressures, it's notable that the core index excluding food and energy continued its decline, dropping from +2.9% in March to +2.1% in May. This inflation rebound is primarily due to external factors such as energy and food prices, which largely explain these discrepancies.
The orchestrated depreciation of the yen from mid-2021, falling from 115 to 150 yen/USD in just over a year, has significantly contributed to Japan's return to inflation, already driven by rising commodity prices. The Tokyo Consumer Price Index (CPI) surged from +0.8% to +3.9% year-on-year, reaching a peak of +4.4% in January 2023. The subsequent decline was partly supported by falling oil prices in 2023.
Alongside CPI developments, Producer Price Index (PPI) trends were more favorable until January 2024, but the yen's drop to 160 against the USD reignited producer prices, which also rose by +2.4% in May.
Japan's inflation outlook remains heavily influenced by exchange rate movements. Given the persistent weakness of the yen and the limited room for maneuvering by the BoJ, it seems reasonable not to expect a trend reversal in Japan's price dynamics at this time. Inflationary measures are therefore expected to continue to rise in the coming months.
领英推荐
BoJ prepares to raise rates to defend the yen
Recent developments in price indices in Japan have reignited questions about a potential rate hike by the BoJ. The deceleration in price increases had temporarily fallen below the +2% target but has now risen back above this level. Monetary authorities in Japan are increasingly pressured by financial markets, which pushed the yen to its lowest level against the dollar since 1986. In the current situation, pressure on the yen is expected to remain intense until the Bank of Japan announces a shift towards "Quantitative Tightening." In recent weeks, BoJ interventions to support the currency have surged to around $62 billion, surpassing the amounts spent on defense in 2022.
Given Japan's current recessionary state, potential normalization of monetary policy appears complicated. However, the yen's decline is a significant concern and is likely to prompt the BoJ to raise interest rates at its upcoming meeting on July 30-31. The adjustment in Japanese monetary policy is expected to be extremely gradual to avoid risking a deeper economic downturn. It will likely remain the most accommodative policy among major central banks for some time, given the weakness in domestic demand in Japan.
The coming months will reveal how a new phase in monetary tightening in July unfolds, assessing the BoJ's prospects in halting the yen's downward spiral. The BoJ's maneuvering room remains tight, suggesting no drastic action on rates, and we anticipate no radical change in Japanese monetary policy. However, the flattening of the yield curve seen in recent quarters seems insufficient to stem the yen's decline, necessitating a rise in BoJ's policy rates.
Bond market still lacks interest
In recent weeks, Japanese government bond yields have not significantly reacted to Japan's negative GDP growth and entry into recession. However, ten-year yields have notably increased since the beginning of the year, rising from just 0.6% annually to 1.1% by the end of May. The correlation between long-term yen rates and the exchange rate has remained high over the past six months, confirming a closely observed link since 2023. Thus, it's unsurprising that the yen's decline from 140 to 160 yen per dollar was accompanied by a rise in long-term yields from 0.6% to 1.1% over the same period.
The steepening of the yield curve has been driven by an increase in long-term rates, while short-term rates remain near 0%. Prospects for capital gains in yen-denominated bonds are highly uncertain and limited to a very short-term horizon, especially if a downward inflationary resurgence, which seems increasingly unlikely, does not materialize. Looking beyond the short term, the likelihood of rate normalization is high, creating a progressively negative environment for the Japanese bond market. Given these conditions, holding yen-denominated bond positions remains unattractive compared to the yields available in other currencies, with Japanese bonds offering no compelling prospects amidst growing rate pressure in the current global environment.
Lowest level in 38 years for the yen against USD
The yen continues its descent, reaching its lowest level since 1986. In a strong downward trend, any rebounds of the yen against the dollar have been short-lived, quickly followed by further declines. In the short term, the yen appears increasingly affected by the lack of decisive action on interest rates by the BoJ, resulting in an unfavorable rate differential for the Japanese currency against all major currencies, particularly the dollar.
For many months, we have been discussing that any appreciation of the yen would likely be short-lived due to sufficiently high yield differentials favoring Japanese investors' interest in holding dollars. We believe that the yield spread will be the primary determinant of the exchange rate level, and in the absence of a more restrictive policy, now somewhat more likely from the BoJ, our outlook continues to favor yen weakness against the US dollar. However, the decline of the Japanese currency is increasingly a significant concern for the BoJ, and we anticipate growing probabilities of a clearer change in its stance towards yen defense. This would likely involve a rate hike and a shift in speculator perceptions. Over a twelve-month horizon, we see a high likelihood of modest yen depreciation.
Nikkei expected to surpass the 40,000 mark again
A few months ago, we pointed out that surpassing its historical peak, the Nikkei could certainly continue to benefit from current enthusiasm to test the 40,000-point level before likely profit-taking sets in. Following a surge that temporarily pushed it to 41,087 points, the volatility seen across global stock markets in April also affected the Japanese market, leading to some profit-taking. The subsequent approximately -10% decline was short-lived, with strong corporate earnings renewing foreign investor interest, attracted by prospects of profit growth and shareholder-friendly reforms after a more uncertain period of business development. However, Japanese stocks are now trading at a valuation of 22.6 times 2024 earnings, which appears high in international comparison. Nevertheless, the current momentum remains positive.