Why is Goldman hoping the "harsh weather" ends before July?
Because as we learned earlier today [16], the ECB will almost certainly not engage in QE in the coming months, if at all (according to Goldman not before 2015 [17]). And as Goldman's Fiona Lake just reported, suddenly there are cracks appearing in the theory that the BOJ will boost QE in April July, in which case we may be looking at a late summer market in which there is no incremental QE from anyone even as the Fed's own QE slows to a trickle before its estimated end in December (of course, the timing of the Untaper is unclear). Needless to say this would be the absolute worst outcome to a market in which everyone has forgotten to trade on fundamentals, and everyone merely "buys" because the global central bank balance sheet is rising.
So in a world in which suddenly there may be no "flow" liquidity boost from anyone, and where Japanese equities, which as recently as late 2013, were said by most to be the slamdunk trade of 2014, have been an epic disappointment for anyone who expected a repeat performance from 2013, what hope is there? Well, according to Goldman, the last remaining hope should no QE boost materialize from either the ECB or BOJ, is that by July the "harsh weather", aka snow in the winter, distortions finally disappear and the economy can blast off on its so many times forecasted "self-sustaining recovery" trajectory.
To wit:
Matching broad expectations for incremental easing against Mr Kuroda’s commentary suggests that there is scope for disappointment with regard to our views on Japanese assets, particularly if skepticism that the BoJ will reach its 2% inflation target in 2 years remains in place. If the BoJ does not announce incremental easing in July, it would remove the near-term Japanese specific kicker to USD/JPY moving higher. However, by July we expect the US economy to be in full recovery from the weather- and inventory-induced slowdown in Q1, and this should push US rates higher and boost the Dollar, including against the Yen. The rise in Japanese break-even inflation may stall, although at this point break-even inflation does not fully reflect the rise in longer-term inflation expectations as published by consensus economics. Finally, Japanese equities would be less likely to outperform other cyclically driven equity markets as global growth recovers.
In other words, short the Yen, not because Japanese QE, initially penciled in by most for April, and now by Goldman for July, may not be coming but because the impact of the winter may finally "taper" by July.
Alas, judging by today's move in rates (hint: not higher), either the US bond market is pricing in what we dubbed in March the "Solar Vortex [18]", aka El Nino, or the endless lie that the US economy is recovering has finally died when it comes to both the bond market, as well as high beta stocks.
That said, we too hope that the impact of "winter weather" will fade by July. However, should that not happen, we already know what the next excuse will be. We presented it yesterday: "Bank Of Japan Prepares To Blame El Nino For Spending Collapse."
Ah, the New Normal - that exciting time when economists have become completely worthless and are replaced by just as worthless weathermen...
Full note from Goldman
Considering the BoJ's next steps: Don’t just focus on incremental easing
In a recent Global Markets Daily we reviewed our outlook for Japanese assets. We reiterated our expectations for a weaker Yen vs the US Dollar, our belief in being long Japanese break-even inflation and our positive stance on Japanese equities, including Japanese banks, which is part of our Top Trade recommendations for 2014. A key, but not necessarily sole, ingredient in these views is incremental easing from the BoJ later in the year, in addition to Quantitative and Qualitative Easing (QQE) already underway since April 2013. As highlighted in the latest Japan Economics Analyst, in our view Japanese core CPI has likely peaked and we expect it to soften notably through Q3 and into year-end. This is in contrast to the forecasts from the BoJ, which expects Japanese core CPI to remain around 1.25% in coming months. Given the time lag of data releases, evidence of this softness may only be available around the October meeting and as a result we see a growing possibility that the Bank will wait to announce additional easing until the Outlook Report’s release in October.
However, we are sticking with our base-line view and still think the BoJ could take further incremental action at its July meeting. First, the BoJ is starting to put in place a framework for monitoring prices more or less in real time, alleviating the effects of time lags in data announcements. Second, we believe that the BoJ, the Abe administration (which is due to unveil its second wave of growth strategies in June), and the Ministry of Finance (which is targeting a second hike in the consumption tax) will unite to mitigate risks. The final decision on whether to raise the tax for a second time will likely depend on 3Q 2014 GDP and share price movements, which significantly influence consumer sentiment. Given its expectation for the consumption tax to rise to 10%, the BoJ may, in our view, see some risk in not taking any action. The consensus also expects a small incremental package in July.
But Mr Kuroda doesn’t sound close to delivering incremental easing
The rhetoric from Mr Kuroda and commentary from the BoJ does not suggest incremental easing is on the cards any time soon. The Bank appears to be very comfortable with the impact that QQE has had so far, noting that growth is well above trend, the output gap has likely closed in its estimation and the Japanese definition of core inflation is likely to reach the 2% price stability target by the middle of the forecasting period, roughly October 2015. Indeed, this commentary also suggests there are risks to our view that the BoJ could deliver incremental easing in July and raises a question we regularly hear from clients: ‘What if the BoJ doesn’t ease in July?’.
Matching broad expectations for incremental easing against Mr Kuroda’s commentary suggests that there is scope for disappointment with regard to our views on Japanese assets, particularly if skepticism that the BoJ will reach its 2% inflation target in 2 years remains in place. If the BoJ does not announce incremental easing in July, it would remove the near-term Japanese specific kicker to USD/JPY moving higher. However, by July we expect the US economy to be in full recovery from the weather- and inventory-induced slowdown in Q1, and this should push US rates higher and boost the Dollar, including against the Yen. The rise in Japanese break-even inflation may stall, although at this point break-even inflation does not fully reflect the rise in longer-term inflation expectations as published by consensus economics. Finally, Japanese equities would be less likely to outperform other cyclically driven equity markets as global growth recovers.
Incremental easing needs to be seen in context of potential developments in the BoJ’s overall easing program
While the market appears to be focused on the likelihood of further incremental easing, it is important to put this in the context of the BoJ’s overall easing package. Under QQE, the BoJ projects an increase in the monetary base at an annual pace of around JPY60-70trn, reaching JPY270trn by end-2014. This implies between JPY5trn and JPY6trn-worth of BoJ asset purchases per month. Any incremental easing is likely to be in the form of an increased purchase amount of Exchange Traded Funds (ETFs), possibly doubling the QQE purchase amount of ETFs, to JPY2trn per year, which would be very small compared with the QQE package in the first place.
It is also worth bearing in mind that the BoJ has only laid out a schedule for QQE to the end of 2014. This timetable dovetails with the Bank’s expectation that it would reach the price stability target of 2% at the earliest possible time horizon of about two years (which was assumed to be around the start of 2015 when the target was first introduced). However, it is becoming clear that it will take somewhat longer to reach that target than initially envisaged. The BoJ expects the target to be reached in the middle of the projection horizon, around October 2015. We view this as optimistic: we do not expect the target to be reached even by the end of our forecasting horizon – indeed, as the latest issue of the Japan Economics Analyst highlights, we expect Japanese core CPI to end 2014 at 0.8% (excluding VAT). Consequently, when considering BoJ easing, it is also important to consider that QQE could be extended. Indeed, the BoJ’s written expression of its current policy is that it will “continue with QQE, aiming to achieve the price stability target of 2%, as long as it is necessary for maintaining that target in a stable manner”.
This could occur in one of two ways. First, the BoJ could explicitly commit to maintaining its balance sheet at JPY270trn, rather than allow it to shrink as assets held mature. Second, and more aggressively, the BoJ could continue to purchase assets and expand its balance sheet through 2015 until its price stability target is reached sustainably. Both of these extensions to QQE would likely be larger than any incremental easing package later this year and also positive for Japanese assets.
Confirming the extension of QQE would be positive for Japanese assets
With this broader context in mind, if the BoJ doesn’t deliver incremental easing in July, it would likely only represent a near-term headwind to our Japanese asset views given the potentially larger easing associated with clarification of QQE, which could come later in the year. The combination of BoJ easing and a US recovery and higher rates still leaves us bullish on USD/JPY with a forecast of 110 in 12 months. By the middle of next year, the market is likely to have turned its attention more squarely towards the Fed’s tightening cycle, which we expect to start in early 2016. By contrast, the BoJ is likely to remain in easing mode, opening up monetary policy differentiation even more clearly than it is now. We continue to expect Japanese break-even inflation to rise. Market pricing of inflation expectations falls short of the rise in longer-dated consensus expectations, which have risen by 50bp to around 1.7% on a 6-10 year horizon post the delivery of QQE. A lack of incremental easing could cause the rise in break-evens to stall; however, a clearer outlook for QQE would reinforce the rise in inflation expectations and push it higher, which dovetails with our views. Finally, any extension of QQE would help Japanese equities perform favourably as the growth cycle picks up.