Since the beginning of the year, macro conditions in Japan have remained quite weak. We expect that Japanese GDP will grow by 0.6% YoY in the current year 2016, and around 0.5% YoY in 2017, under a Low Low Trap scenario. Our scenario has been adjusted downward for a stronger yen than previously expected. The trigger for a stronger yen has been the “new” risk environment (global higher uncertainty) induced by the UK referendum.
A stronger yen is expected to hit economic performance in Japan mainly through Profits/Capex and Net Trade. Moreover, it’s going to add concern with respect to Corporate Profitability that appears to have already peaked, especially with external demand far from buoyant.
The inflation outlook has marginally deteriorated since the beginning of the year: although the path in H2 remains upward, we expect inflation around 0.5% YoY by the end of 2016 and marginally increasing in 2017. Inflation will remain far below the BoJ target until the next planned Consumption Tax hike in 2019.
Looking forward, Japan is still waiting for more proactive and supportive policies to fix its conditions.
The last elections for the Upper House, on the 10th of July, saw First Minister Abe’s coalition (LDP plus Komeito) gain additional seats. This outcome takes the country in an even more stable political direction and sets the stage for more decisive action on some sort of intervention such as the fiscal package. The 28 trillion yen ($277 billion, 5.6% GDP) stimulus package released at the beginning of August goes in this direction but a lot remains to be done. The total amount of this stimulus is a multi-years target, and the direct outlays are only a minor share of it. Most of the package is not “certain” (private participation is also required) and it’s difficult to measure any reliable impact from it.
On the monetary policy side, the BOJ continues to support financial markets by injecting vast incremental amounts of yen liquidity into the system. The 2% inflation target has become a medium term target, with the BOJ currently vowing to reach it in fiscal 2017, but admits that “the risks are high for reaching the CPI target in the timeframe”. The BOJ at the July 29 meeting increased the purchases of ETFS from 3.3T to 6T a year, leaving interest rates and JGP purchases unaltered: the increase in the qualitative easing was motivated by Brexit and the slowdown in emerging markets. An assessment of the effectiveness of the BOJ’s current stimulus policies is scheduled for September, and could well lead to the implementation of further policies. In fact, further stimulus may be enacted by the Kuroda led BOJ in coming months if needed, in the goal to achieve the 2% CPI target “as soon as possible”.
In a more international context, Abe is ready to ratify the Trans-Pacific Partnership deal (TPP) because of its relevance to Japan’s internal reform process. In fact, in the agriculture sector, the deal could force a kind of revolution towards a more competitive and productive way to operate. Vested interests in the sector are strong and Abe could take advantage of an external input rule to engineer big changes. However, the entire deal is stuck, waiting for the US signature that is becoming more and more caught up in the presidential election campaign.
From an investment perspective, we keep a very moderate preference for Japanese Equity. The strong JPY appreciation, further triggered by Brexit, could have a negative effect on Japanese corporations. However, a new wave of policy interventions could support the market in the short term.