With the first arrow of Abenomics perhaps hitting its limit, it will be the second and third arrows that need to occur quickly and aggressively to carry this momentum forward (and for the economy to grow into stock valuations). Barclays lays out 15 of its most frequently asked questions below but concerns remain as the BoJ’s planned absorption of nearly 80% of new JGB issuance from the markets this fiscal year has triggered a dramatic change not only in JGB supply/demand and ownership structure but in the JGB market risk profile itself, which has moved from “low carry, low volatility and high liquidity (superior to other assets from perspective of risk-adjusted returns or Sharpe ratio)” to “low carry, high volatility and low liquidity (inferior from same perspective)”. Barclays added that with a wave of major political and policy events ahead, starting with a crucial Upper House election, there was no big change in the basic belief among foreign investors that Japan is likely to be the main source of surprise for the global economy and of volatility in financial markets.
Q1: Is the BoJ’s 2% price stability target achievable?
A1: It will be difficult through monetary easing alone
Q2: Where might a surprise appear in inflation trends?
A2: Inflation tends to jump unexpectedly when a combination of monetary easing and significant fiscal expansion coincides with some sort of supply shock.
Q3: What transmission channel is the BoJ envisioning for achieving its inflation target?
A3: Since the interest rate and credit channels are unlikely to recover anytime soon, the BoJ will have to depend largely on more accommodative financial conditions via higher share prices and a weaker yen.
Q4: What other monetary policy actions are expected?
A4: We think the BoJ will likely be compelled to ease again in 2H FY13 (most likely in October), consisting mainly of increased purchasing of ETFs as the most feasible risk asset.
Q5: How do we describe the government’s fiscal policy stance for 2013-14?
A5: Assuming no additional fiscal measures, fiscal policy will shift from a markedly expansionary stance relative to other developed nations in 2013 to an abrupt contractionary stance next year.
Q6: What is the likelihood of a return to a public-spending-driven economic recovery?
A6: If the economy is underpinned by strong overseas demand (robust exports), as in the Koizumi era, it would reduce the chances of a major fiscal expansion or resulting economic rebound fueled by public works.
Q7: Is government debt sustainable?
A7: This will depend on growth initiatives. If the government continues to depend unduly on QQE without a proper growth strategy (sluggish potential growth), the possibility of a ‘sell-Japan’ scenario would reemerge over the long term.
Q8: How has the government’s growth strategy progressed?
A8: There has been no notable progress yet. Momentum for growth initiatives may pick up depending on the Upper House election results, but key measures such as a corporate tax cut and easing of job dismissal regulations could take considerable time.
Q9: Are Japanese stocks overvalued?
A9: Japanese stocks are superficially rich as measured by valuations such as P/E. However, we believe share prices have further upside as long as excess liquidity continues to curb the ERP.
Q10: What will be necessary to ensure a more sustained rise in share prices?
A10: A more sustained rise in the liquidity-driven stock market will require a return of surplus funds to shareholders when real interest rates fall into negative territory, a cut in corporate tax rates, and higher financial leverage.
Q11: How has the structure of JGB markets changed since the launch of QQE?
A11: The post-QQE risk profile of JGB markets has changed dramatically from “low carry, low volatility and high liquidity (high Sharpe ratio)” to “low carry, high volatility and low liquidity (low Sharpe ratio).”
Q12: Will QQE trigger significant portfolio rebalancing by financial institutions?
A12: Banks will reduce their JGB holdings substantially in 2013-14. Still, their considerably higher risk tolerance levels compared with the VaR shock of 2003 should act as a buffer for JGB markets.
Q13: Will the yen’s decline accelerate? What is the risk of reversal to yen appreciation?
A13: The fall in the yen’s value could hasten if a further BoJ easing coincides with a reduction by the Fed in its QE. However, from a supply/demand perspective, purchasing of Japanese shares by overseas investors should offset the effect of portfolio rebalancing by domestic investors, suggesting that the pace of yen depreciation should slow.
Q14: What political developments can be expected after the Upper House election?
A14: If the LDP secures a majority in the Upper House, the government will have control of both houses for the first time in six years, setting the stage for a long, stable administration. The political stability could be the driving force for growth initiatives.
Q15: What are the best- and worst-case scenarios for Abenomics?
A15: The best-case scenario is the LDP wins a large majority in the Upper House election and more momentum for growth initiatives, along with QQE to ease near-term deflationary pressure. The worst case would be a retreat in growth initiatives and prolonged overdependence on QQE.
Whether the markets go for a buy-Japan or sell-Japan scenario will depend in good part on the results of important policy and political events in the next three months. Of particular note are: 1) BoJ Monetary Policy Meetings; 2) the Council on Economic and Fiscal Policy’s Basic Stance for Economic and Fiscal Management, scheduled for release in June, and the outline of growth initiatives by the Industrial Competitiveness Council and Council for Regulatory Reform; and 3) the Upper House election (as well as the Tokyo Metropolitan Assembly election, a prelude for the national poll).