Excerpted from JPMorgan CIO Michael Cembalest 2016 Outlook,
Something is wrong with this picture. In the US and Japan, corporate profits sank during the global financial crisis. In the US, the profit recovery was accompanied by a recovery in household income. In Japan, however, corporate profits and household income moved in opposite directions, as dynamics that helped profits recover did not help consumers.
How can we explain the outcome in Japan? The benefits of a weak Yen are mostly concentrated among large corporations, given translation gains on offshore non-Yen income relative to Yen-denominated costs. For smaller companies and households, a weaker Yen simply resulted in imported inflation. While consumer spending has stabilized after a decline caused by the imposition of a Value Added Tax in 2014, there are few signs of a rebound to pre-VAT levels. Japanese GDP growth has been volatile and averaged 1.5% in 2015; we’re expecting a similar outcome in 2016.
In October 2015, the Bank of Japan did not take further steps which markets were anticipating (e.g., an increase in equity ETF purchases from ¥3tn per year, an increase in REIT purchases from ¥90bn per year or an increase in government bond purchases from ¥80tn per year). Perhaps concerns about the negative domestic impacts from a weaker Yen are affecting BoJ policy.
Our contacts in Japan believe that the BoJ is no longer being pre-emptive, and will wait until November 2016 to act.
The Japanese experiment.
There are few precedents for the kind of experiment Japan is conducting. At the current pace of BoJ purchases, private sector banks might actually run out of JGBs by the end of 2016, at which point the BoJ would have to buy them directly from the non-bank private sector; I think it’s fair to say that no one really knows what would happen then.
One thing is certain: like riding a tiger the BoJ can’t stop now, and has little choice but to continue with debt monetization as Japan’s Federal debt grows higher, and as it veers further and further into the economic unknown.