Abe's Days Numbered? DB Warns Japan PM "May Be Forced Out" Leading To Spike In Yields

Almost exactly ten years ago, on September 12, 2007 Japan's current prime minister Shinzo Abe resigned less than a year into a tenure dogged by scandals, the suicide of a minister, a raft of resignations and corruption allegations, and a humiliating election drubbing for his Liberal Democratic Party. Never one to shrink away from resposibility, Abe blamed it on crippling diarrhea:

Shinzo Abe resigned as Prime Minister, claiming that diarrhea was preventing him from carrying out his duties. The diarrhea was due to ulcerative colitis, a bowel illness caused by ulcers. Abe had suffered from this illness for decades, but after becoming Prime Minister, the stress of his job apparently made the symptoms worse.

Apparently it did not prevent him from taking on the job again some five years later, when he was reinserted in the prime ministerial position again, largely as a smokescreen meant to keep the government together as BOJ's then-new governor Haruhiko Kuroda unleashed the greatest "wealth creation" and bond monetization experiment in the history of Japan, which has culminated with the Japanese central bank owning nearly 100% of Japan's GDP in Japanese Government Bonds.

Unfortunately for Abe, it may be time to buy Imodium again.

As Deutsche Bank reports, following a fresh series of political scandals, the Abe cabinet's approval ratings have kept falling and are now in the sub-40% "danger zone" and as DB's Makoto Yamashita writes, it is now starting to look as though Prime Minister Shinzo Abe might be forced out of office until the Liberal  Democratic Party leadership race scheduled for September 2018, "in which case JGB yields might be at risk of climbing quite significantly."

Ironically, in many ways this mirrors Abe's first fall from grace. This is what the Economist wrote some ten years ago:

"Mr Abe's government was initially very popular. Yet the tide in Mr Abe's affairs only ebbed. True, early on he made a notable opening towards China, with whom relations had been strained under Mr Koizumi. Other than that, Mr Abe proved unable to impose discipline upon a cabinet of the corrupt and incompetent. Worse, he had a tin ear for the political mood. Voters, it had turned out, had been beguiled more by Mr Koizumi the messenger than by his message of structural reform, which entailed pain and uncertainty, notably in Japan's rural regions and among the old. Mr Abe failed to address these concerns."

This time around, the reason for the German bank's dour outlook is because sub-40% approval ratings have almost invariably triggered changes of leadership around one year later over the past two decades and have always resulted in significant national election defeats.

"We will thus be watching quite closely to see whether Abe's upcoming cabinet reshuffle proves successful in regaining the 40% level. Given that this political risk is a yen-specific factor, it should be sufficient to buy foreign bonds as a hedge against the possibility of a "risk off" decline in interest rates."

And since the financial world is far more interested in the implications of Abe's departure on JGBs than his actual political fate, here is the background: while the BOJ has once again proved successful in curbing upward pressure on the 10y JGB yield by conducting a fixed-rate operation, it continues to buy more 5y–10y JGBs than are being issued each month and is thus likely to reduce its purchases when yields are declining. Moreover, the BOJ has this month left its offer amounts in the super-long sector unchanged (at least to this point) despite yields having climbed quite considerably. The central bank thus appears willing to tolerate steepening of the >10y curve, which may suggest that a "shock" political event like an Abe resignation may lead to an accelerated selloff off the longest-dated Japanese bonds.

As for Abe's fate, here are the details:

Abe cabinet's approval ratings already in dangerous territory:  the Yomiuri Shimbun reported on July 10 that the Abe cabinet's approval rating had fallen 13%pt from its previous survey to 36%, while other polls have shown a 5%pt decline to 33% (Asahi) and a 13%pt decline to 35% (NHK). An approval rating of 40% or higher is generally considered necessary for a prime minister to remain in office. The Yomiuri Shimbun also reported a 10% decline in the Liberal Democratic Party's approval rating to 31%, a 1%pt decline for the Democratic Party to just 6%, and a 7%pt increase for independents to 47%. Some have suggested that  Prime Minister Shinzo Abe might still be "safe" for want of opposition, but past experience indicates that might not necessarily be the case.

And, as Deutsche Bank warns, it is now beginning to look as though Abe might be forced out of office prior to the LDP leadership race scheduled for September 2018. Here's why:

For starters, no administration since 1997 has survived for more than a year after recording sub-40% cabinet approval ratings in consecutive months, although Keizo Obuchi should probably be considered an exception given that his cabinet's approval rating had improved from 25% initially to 40% by the time he was forced to stand down due to the abovementioned diarrhea. Only Junichiro Koizumi served out his full term, having consistently maintained approval ratings above 40%. It is possible that Abe will redeem himself with his upcoming cabinet reshuffle, but failure to regain the 40% level would almost certainly point to a change of prime minister before the end of 2018 if past experience is any guide.

Second, the next lower house election needs to be called by December 2018, and it is important to note that each upper or lower house election since 2003 contested with a sub-40% cabinet approval rating has resulted in defeat for the incumbent party (chart below), with changes of government occurring after Abe's July 2007 upper house election defeat, Taro Aso's August 2009 lower house defeat, and Yoshihiko Noda's December 2012 lower house defeat. The next LDP leadership race is scheduled for September 2018, and it seems highly unlikely that party members would throw their support behind someone with a sub-40% cabinet approval ratings. The lack of unified opposition is indeed a significant difference from the past, but it is quite conceivable that independents will have combined forces to establish a new party by the end of this year or soon thereafter.

Third, Abe will struggle to proceed with his attempt to revise the Constitution if his approval rating remains so low. Even if the necessary two-thirds majority can be secured in the Diet, it is difficult to envisage 50% support in a national referendum. There does not currently appear to be any headroom to use fiscal or monetary policy to boost the government's popularity, with the Abe administration having already compiled a roughly JPY28.1 trillion "Economic Stimulus Package for Realizing Investment for the Future" under the second FY2016 supplementary budget. Some market participants appear to believe that further pump-priming could be on the cards, but recent experience has in any case demonstrated that even that might not be enough to win back the support of voters.

Fourth, while markets may be finding it difficult to envisage a post-Abe government, Kyodo recently claimed that Foreign Minister Fumio Kishida intends to stand down around the time of the cabinet reshuffle (although we are as yet unsure as to the accuracy or veracity of this report). Kishida heads a faction thought to consist of around 46 LDP lawmakers (chart below)). This faction has its origins in the Kochi Kai launched by then Prime Minister Hayato Ikeda back in 1957, and is thought to be more dovish than Abe with regard to matters of diplomacy or the possibility of constitutional reform. Kishida is believed to have reiterated on June 28 that he remains reluctant to revise war-renouncing Article 9 of the Constitution, and Finance Minister Taro Aso might also emerge as a contender now that he is effectively heading the LDP's  second largest faction. As a result, expect talk of a successor to Abe to heat up unless the upcoming cabinet reshuffle does prove successful in reversing recent declines in popularity.

Finally, here's why the above matters for Japanese risk assets, from Deutsche Bank:

We have been stressing the potential for political risk to drive JPY rates higher for several weeks now, but have yet to see this possibility priced into the market. This is somewhat puzzling given that the demise of Abe would almost certain have ramifications for the BOJ (with Abe having been such a strong support of Governor Haruhiko Kuroda). The current climate of low bond market volatility thus looks likely to come to an end sooner rather than later. Weak inflation has of course helped to keep JPY rates anchored, but that might not be enough if political instability does develop into a major market theme. We will therefore be  keeping a close eye on poll results following Abe's upcoming cabinet reshuffle. 

And for those who are seeking a pair-trade variant to a long position in govvies elsewhere, DB recommends shorting Japan dur to said rising Abe risk:

Given that this political risk is a yen-specific factor, it should be sufficient to buy foreign bonds as a hedge against the possibility of a (global) "risk off" decline in interest rates (including super-long JGB yields).

As for Abe's life after resigning - for the second time, - we are confident he will be fine following a few unpleasant run-ins, pardon the pun, with the bathroom which will once again be scapegoated for his failures, and several Imodium prescriptions. Who knows, after Japan's economy crashes for a few more years, we may just see the third coming of prime minister Abe to serve as the smokescreen to the BOJ one last time, which at that point will be forced to buy, well, everything to keep the market from imploding.


AGuy runswithscissors Mon, 07/17/2017 - 00:28 Permalink

I doubt Japanese bond yields will go up appreciatively. if they did, Japan would be forced into a Hard default. Its likely that JCB will go on buying and keeping yields low indefinitely. Eventually, the Yen will become worthless.

Japan series of PM will be like Russian dolls. The newer PM's will just do "bigger" stimulus programs. Japan has long been insolvent, both financially and in demographics.

In reply to by runswithscissors

earleflorida Sun, 07/16/2017 - 20:15 Permalink

just like a good financial kamakazi is welded to his seat--- abes flight of fiscal prosperity was a one-way ticket of no return---diving for black`pearls?

Jack Oliver Sun, 07/16/2017 - 20:30 Permalink

Once the retiring Japanese realise that their hard earned superannuation has been stolen and replaced with freshly printed stuff - well - there is going to be FUCKING anarchy !

Massive QE ( US - EU - Japan ) undermines economies and national savings - China has to print just to keep up !!

It always get back to the fact that - China ( the world's largest gold producer AND buyer ) and Russia - have not been hoarding FUCKING gold for NOTHING !!

Add to that India's ( gold has always held a 'special' place in the Indian heart ) investments in Iranian energy ( gas fields ) - which ( like Russia and China ) will be done outside the US dollar - The US dollar has become a pariah !!

The 'empire' will soon collapse because, they have no FUCKING other monetary options - a fool and his gold are soon parted !!

AGuy Jack Oliver Mon, 07/17/2017 - 00:39 Permalink

"Once the retiring Japanese realise that their hard earned superannuation has been stolen and replaced with freshly printed stuff - well - there is going to be FUCKING anarchy !"

You don't understand Japan. There are almost no young people left. Most of the people are now eldery. the Majority of people are dependent on gov't assistance.

"It always get back to the fact that - China ( the world's largest gold producer AND buyer ) and Russia - have not been hoarding FUCKING gold for NOTHING !!"

China is still largely a country of peasants. China PMs holding are dwarfed by its debt and mal-investments. When the West is no longer able to support its export driven economy its going to either implode or or go into a military keyesiums driven expansion (think Pre-WW2 Japan).

There will be no good outcomes this round, only increasing precarious predicaments: Marxism type rvolutions, more civil wars, ideology wars, etc.

"The 'empire' will soon collapse because, they have no FUCKING other monetary options"

War and revolutions are always on the table. Typcially when monetary options are exhausted Military options move up as the next option. Throw in some bread and ciruses too.

In reply to by Jack Oliver

Jack Oliver AGuy Mon, 07/17/2017 - 02:02 Permalink

You obviously don't understand the gold 'standard' - When ( not if ) gold skyrockets ( China will soon control the gold price ) China will be the top dog - The gold 'standard' allows a country holding copious amounts of GOLD ( like China ) to print 10x the value of that gold in paper currency !!

Therefore it is TRUELY backed by GOLD !!

This IS economics rule # ONE !!!

In reply to by AGuy

Bank_sters Sun, 07/16/2017 - 20:40 Permalink

Yields... lol  Lemme see.  Do I buy JGbS, UST, Mexican 100 year bonds or toilet paper?   I'll bet toilet paper goes up more and is softer to wipe with.    

Ben A Drill Sun, 07/16/2017 - 21:22 Permalink

Who would want the job?

Fucashima is never going to be fixed. Just a money pit in cleanup alone.
Aging population
Lives to close to N. Korea and China
Earthquake central
Fish diet. Yeah, no cancer in that.

nmewn Sun, 07/16/2017 - 21:45 Permalink

Surely Abe can get Krugman over there on an exhaust belching jet to give him a refresher course on the Keynesian monetary sciences and its relationship to societies at large.Otherwise known as socio-economics ;-)

Let it Go Sun, 07/16/2017 - 23:11 Permalink

This may mean the yen will finally give way and collapse. the myth promoted by the central banks that a major currency cannot fail is accepted as fact by many people however, the rapid demise of either the yen or the euro is all that will be needed to reveal the truth. When a major currency fails it will remind people everywhere that our system of fiat money is held together only by faith in the system and a prayer.Japan's public debt, which stands at around 250% of its GDP is the highest in the industrialized world. In the future Japan's debt can only be addressed by printing more money and debasing the yen. The article below explores how when Japan crumbles it will be felt across the world. http://brucewilds.blogspot.com/2016/06/the-yen-and-its-failure-to-fail.html