The recent volatility seen in Japanese financial markets has spawned plenty of column inches suggesting that it marks the point at which Abenomics was revealed to be a failure. In particular, the “spike” in JGB yields, it has been argued, highlights that the BoJ can not simultaneously hold down long rates and raise inflation to its target. Ergo, recent market moves show that Abenomics is doomed to fail. But this narrative, so seductive to those ideologically opposed to QE and the Japan perma-bears, is nonsense.
Let’s start with the moves in JGB yields. Yes, 10Y yields rose 25bps over May. But JGBs were far from alone in this. 10Y UST yields were up 46bps over the month and 10Y Bund yields up 29bps. And, in any case, at 86bps currently, 10Y yields remain exceedingly low by any measure and well below their long-run average. Certainly, the idea that these sorts of moves represent any sort of threat to Japanese banks’ balance sheets is also nonsensical.
Of course, Japan’s equity markets also saw large falls at the end of May, with the weakness continuing into June. That has left the Nikkei down almost 18% from its peak on 22 May. But that still leaves it up 24% so far this year, and up almost 50% since mid-November. By any measure, these represent impressive gains, boosting wealth and confidence and lowering funding costs for firms.
Yen against key currenciesSource: Bloomberg
The fall in the yen has also come in for plenty of criticism, including from those that are on very shaky ground where the subject of currency manipulation is concerned. This, say some, is no way to deliver a sustainable recovery. Indeed, the Financial Times has gone so far as to suggest that, by weakening the yen, Japan is merely stealing growth from its neighbours. Ignoring the absurd suggestion that there is a finite amount of growth to go around, it is far from clear that the yen is grossly undervalued. Whether against a key competitor’s currency, the Korean won, or more generally in trade-weighted terms, even before its recent re-appreciation the yen remained stronger than its level pre-financial crisis, a period which saw Japanese exporters broadly maintain market share (in contrast to the post-Lehman collapse period – see chart below). It’s unclear why those criticising the fall in the yen believe that Japan should permanently saddle itself with a too-strong exchange rate.
Japanese and global trade growth**Japanese export markets data show the growth in imports weighted according totheir rolling share in Japanese exports. Source: BoJ, CPB and Daiwa Capital Markets Europe Ltd.
The final criticism leveled at Abenomics is that it is tackling the wrong set of issues – the Japanese economy’s problems are structural, not cyclical. This, it is argued, calls for structural reform, not macro stimulus. But this is to confuse two separate issues. Japan, along with every other economy, could benefit from structural reforms aimed at raising long-term growth. But it is difficult to see how structural reform, by itself, could end deflation. Indeed, reforms that raised the potential growth rate could actually add to deflationary pressures if they were not accompanied by a commensurate increase in demand. That is why macro stimulus and structural reform need to go hand-in-hand - exactly what Shinzo Abe’s government is doing. And, of course, structural reform, in which there are often significant losers, is much easier carried out against a backdrop of strong growth and rising wages and prices.
Ultimately, Abenomics is designed to boost growth and eliminate deflation. And here, while still very early days, the signs are promising. Japan recorded the fastest growth in the G7 in the first quarter of the year, while available data suggest that strong growth has been maintained into the second quarter of the year. Confidence in both the consumer and business sectors continues to rise. The labour market, meanwhile, continues to firm, with the job-to-applicant ratio in April rising to its highest level since July 2008. And with the labour market tightening, there are signs of stirrings in earnings, with bonuses in particular seeing strong positive growth. And all of this is before any of the actual stimulus has had chance to have a direct impact – testament to the power of a positive message and vigorous policy promises to stir confidence. Expect an ongoing boost to growth as the stimulus, both fiscal and monetary, including the lagged effect of the fall in the yen, builds through the remainder of this year.
So, Abenomics is working, and will continue to work. Indeed, in terms of the real economy, it’s probably working better than anyone dared hope. Of course it was never going to be plain sailing – ending over a decade and a half of deflation means that the BoJ is having to undertake policy actions unprecedented in the post-war developed world. But if inflation is indeed a monetary phenomenon, then printing sufficient of it will eventually deliver the 2% inflation that the BoJ is aiming for. A few days or weeks of relative market turbulence are no reason to believe that Abenomics is ultimately doomed to fail.
Grant Lewis, Head of Research