Japan is back...maybe
One of the clear trends emerging so far this year is the clear distinction between economic trends in the US, Europe and Asia. As we wrote last week, inflation is showing early signs of a peak in the US market. While jobs remain very strong, there are many indicators suggesting the recent interest rate hikes are working and will drive things to a halt in the coming months.
Things are moving in the same direction in Europe, but with a lag. The European Central Bank moved later than the US Fed in hiking rates and that is showing in the data flowing through.
But the big surprise over the past few weeks has been between Asia and the rest of the world. Australia’s inflation numbers out this week were worse than expected. The numbers have a lag to them, but that will put pressure on the Reserve Bank to push at least one more 25 basis point hike with a 50% chance of another in March before a pause.
Inflation in Japan
Japan is the wildcard and the focus of our attention this week. After decades of anaemic growth and almost zero inflation, things are finally starting to move and we believe Japan will become a more focus in global markets, particularly among Asian investors, towards mid 2023.
Japanese inflation grew by 4% in December, much higher than expected. To put this in perspective, December’s inflation number was the highest since January 1991. Inflationary pressure came from all components and was consistent across the board.
Policymakers are probably in shock. Christmas has come early.
The big surprise has been in Japanese companies having the ability to pass on higher input costs. Inflation is now moving from taboo to an actual economic reality. We think inflation will continue to flow through Japan this year and spread across the Asian region. Keep in mind that Japan is the world’s third-largest economy.
Impact of Japanese inflation
Japan’s central bank (Bank of Japan or BOJ) has had to fight deflation for several decades. That has mean negative interest rates and a phenomenal amount of bond buying just to keep things afloat. This type of yield control has seen rates near zero for a long time. The BOJ surprised last month by widening rates from ±25bpts to ±50bpts.
It was a big signal to the market that the status quo is changing. Despite higher inflation, the BOJ didn’t follow through this month with more change. It has the market on its toes, but with a new leader expected in April, there are rising hopes that interest rates will need to change in Japan over the next few months.
The big implication is this. Many Japanese investors, particularly retirement funds and institutional investors, have had to rely on offshore investing for decades because yields and returns have been extremely low at home. There has been a significant flood of Japanese money chasing assets in the US, Europe, Canada, and even Australia.
If Japanese interest rates start to rise, there will be a shift among Japanese investors that maybe it’s time to bring that money back home. Should that happen, it will provide upward pressure on interest rates across all other global markets.
It’s not a simple formula, and one that has failed to materialise many times over the past 40 years because the Japanese economy has continuously disappointed. But it’s something that should be on the radar this year.
In November last year, I cautioned against the Japanese Yen reaching extremely low levels against the US dollar and said it was prime for a bounce back.
The bounce back in the Yen has been significant. If the BOJ finally starts to adjust its ultra low rate policy in the next few months and investors start repatriating money back home from abroad, we could see the Japanese yen strengthen even further. A level of 110-115 is not out of the question, but requires extreme patience and prudent risk management.
Strong Japan is positive for many
A bounce back in the Japanese economy is positive to many, particularly Australia. Japan is Australia’s second-largest trading partner, but a long way behind China. Key imports are energy, iron ore, copper and raw aluminium.
Australia, India and the United States signed a quad lateral security agreement with Japan last year (also known as the Quad), which while being extremely political in nature, nevertheless underscores the ties between these countries are genuine trading partners. It also follows on from the Trans-Pacific Partnership initiative during the Obama era.
Japan’s economic recovery also has implications for the rest of the ASEAN economies, which will spill over into the region. So with a low population growth rate and one of the world’s highest life expectancy rates, perhaps 2023 could be the economic turning point for Japan to get growth back on the map.