Japan: Is Abenomics Running Out Of Steam?

The Bank of Japan (BOJ) met analysts’ expectations today by making no changes in monetary policy. It will continue its aggressive quantitative easing policy of increasing the monetary base at an annual pace of 60-70 trillion yen. The composition also remains the same (mainly Japanese government bonds, 50 trillion, but also exchange-traded funds (ETFs), real estate investment trusts (REITs), commercial paper, and corporate bonds). The BOJ indicated that Japan’s economy is “… starting to recover moderately.”

This confirmation of continued monetary easing has not been sufficient to lift Japanese equities from their recent softness. The WisdomTree Japan Hedged Equity ETF, DXJ, which excludes the effects of fluctuations in the yen-US dollar exchange rate, is down almost 5% over the last month. Those who looked for the BOJ to announce further monetary easing today were disappointed, particularly since the tone of Governor Kuroda’s remarks gave no encouragement to such views.

The problem does not appear to be the recent data on the Japanese economy, which indeed indicate that a moderate recovery is underway. Japan’s economy advanced at a 4.1% pace in the first quarter, far faster than the growth in the US economy and in Europe. The latest OECD Composite Leading Indicators for Japan continue to trend upward.

Investors’ concerns appear to be centered on the weakness to date of the second and third “arrows” of Abenomics, fiscal stimulus and economic reform. The first arrow, monetary stimulus, is on track. The announced reforms to date have not targeted the areas most needing reform: the labor market, agriculture, and the service sector. The intended fiscal stimulus threatens to turn into a fiscal headwind if plans for a two-step rise in the sales tax in 2014 and 2015 go into effect. Abe has yet to pronounce his intentions on this matter, but BOJ Governor Kuroda has made clear both his view that the tax increases should go forward and his expectation that the economic recovery would not be affected significantly by the higher taxes.

We are maintaining our Japan overweight positions in our international and global portfolios, as we anticipate that the Japanese economy will continue to be among the economic growth leaders in the coming months and in 2014. More significant Japanese economic reforms are likely to be announced in September. It would not be surprising to see either an extended timetable or scaling down by the government of the sales tax increases. And should the recovery or the recent rise in inflation appear to falter, the BOJ would very likely step in with further stimulus.

BY Bill Witherell