Chopper wars

26 Jul 2016

INTRODUCTION

We believe that Japanese policymakers are likely to announce a significant monetary and fiscal stimulus package in the near future. We think that the package will involve at least a modest rate cut and an expansion of the asset purchase programme on the monetary front and at least a ten trillion yen package on the fiscal front. We think that the risks are skewed to the upside – a bigger and bolder package is more likely than a modest package. However, we are not sufficiently confident that the Japanese will move the monetary goalposts and temporarily or permanently raise the inflation target. Given the current state of the Japanese economy, the scale of the public debt burden and the stock of government debt already sitting on the central bank’s balance sheet we believe that Japan has already been engaging in ‘stealth helicopter drops’ and another major stimulus package should be considered a helicopter drop in all but name. Indeed, investors are likely to view additional monetary stimulus as a helicopter drop, particularly if it coincides with the release of new information on the government’s fiscal priorities that would create the impression of close policy coordination between the Bank of Japan and the Abe government.

This note sets out our thinking on the size and scope of that package, the likely macroeconomic impact and the ramifications for global asset prices. Key for asset prices is the extent to which investors see coordinated stimulus in Japan as reflationary. In this event, we would expected nominal bond yields to rise (particularly at longer maturities) even as the BoJ expands its QE; risk assets to rally and the yen to weaken.

WHY NOW ?

One might reasonably ask why the Japanese would be launching a(nother) stimulus package – and in particular why now? Our answer is in three parts.

First, the timing is right. Prime Minister Shinzo Abe has just earned a renewed electoral mandate to press ahead with reforms. The elections for the upper house of Japan’s parliament have delivered Abe a super majority in both houses.

Second, the economic case for action is compelling. Whilst some measure of reflation has been achieved, the economy has not achieved escape velocity and the price stability target of 2% remains out of reach. If the acid test of QQE was this year’s wage round then the current package has failed. Moreover, there is scant evidence of any material improvement on the supply side. The third arrow of Abenomics (structural reforms) has not hit the target – if it was ever even fired. Abe has pledged to tackle Japan’s demographic problems of low birth rate and an ageing population head-on, but has yet to deliver the measures that could solve those problems.

The third and perhaps most compelling reason for expecting the imminent announcement of a fresh stimulus package is that Abe has promised a ‘bold’ action. In the immediate aftermath of his election victory Abe promised: ‘We are going to make bold investment into seeds of future growth’ and noted that ‘We have to accelerate Abenomics to meet the public’s expectations’. Likewise, he was crystal clear about the need to press ahead in comments around a meeting with Bernanke earlier this month: ‘We are only halfway to the exit from deflation, we want to be steadfast in accelerating our breakaway from deflation’. It is unclear why Abe would deliberately and consistently raise expectations of a major stimulus package which he has the parliamentary muscle to implement if he did not intend to deliver.

 

THE TIMELINE

Although we expect the authorities to announce additional monetary and fiscal measures in the near future and we believe these two elements make sense as a part of a single stimulus package we do not expect the authorities to announce those measures together. Instead, we expect the fiscal and monetary authorities to stick to the existing timetables.

The timeline for announcing fiscal policy is inherently fuzzy. Work on calibrating the size, design and financing of the package is clearly already underway and may continue for the next month. It is unlikely that the finished article – in the form of a supplementary budget – will emerge before September and may not pass into law until the October. The peak impact of these measures on demand is therefore unlikely to be felt until 2017, although asset prices and activity may start to react as soon as the broad parameters of the package are known. Still, we expect that information about the intended size and contours of the program will become clearer in the weeks ahead.

The timeline is more straightforward on the monetary side. There are Bank of Japan policy meetings slated for the 29 July and 21 September. If the Bank of Japan wants to wait until the precise details of the fiscal package are known then we should not expect fresh monetary stimulus to be announced until the September meeting. However, we presume that Governor Kuroda is already familiar with Abe’s broad intentions on size. In any case, there is already a strong argument for fresh monetary stimulus and failure to deliver may weaken investors’ confidence in the Bank of Japan’s stomach for the fight to achieve price stability, which could lead to a counterproductive tightening in financial conditions. As one of Abe’s economic advisers recently commented about the July decision: ‘I will really want to know why if there is a decision not to do anything. Markets will react and the yen will probably strengthen.’

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