- Inflation rates in Japan and the U.S. are currently below central bank goals. Japan, however, is significantly below target.
- Negative rates have been a reality (or close reality in real terms) for a few countries.
- The proposed 200 bps sales tax increase in Japan will be a key variable to watch for in the FX and JGB market.
“Whatever it takes” is an aggressive mandate for monetary policy—nothing short of historic. Momentous action is called for, however, in the case of Japan. The Bank of Japan (BOJ) is attempting to rescue the country from its decade long economic slump. Accordingly, Japanese central bankers have passed some of the most aggressive policy measures ever seen. Despite these actions, Japan is still plagued with subpar inflation growth and is far from its consumer price index goal. Across the Pacific, the U.S. seems to be in a similar boat.
Much like the BOJ, the Federal Reserve (the Fed) is still shooting for an elusive inflation figure, despite historically loose monetary policy. Janet Yellen’s board is looking for Core Personal Consumption Expenditure (PCE) to hit 1.5%-1.7% in 2016 and 2% in the long run. In the latest data release, PCE index year-over-year (YoY) came in at 0.58%. The trend is favorable, with last month’s figure being 14 bps lower, but current levels are still far from the Fed’s 1.5%-1.7% 2016 target. Interestingly enough, PCE less food and energy (Core PCE) is a lot closer to the Fed’s target. Core PCE YoY reached 1.41% in the same release. This could lead investors to believe that food and energy is preventing the Fed from tightening more aggressively. The Fed’s mandate requires the board to also watch unemployment. Thankfully, the labor market has been much more cooperative. The most recent Bureau of Labor Statistics data puts us right in the middle of the Fed’s long term goal of 4.8%-5%. Ultimately, the Fed will need to balance its two mandates with the appropriate policy. It’s interesting to note that the BOJ, however, does not include employment in their official mandate.
The two primary objectives of the BOJ are to maintain financial system stability and price stability. Slightly different from the Fed’s, Japan’s mandate is very much reflective of the country’s inflation issues. Japan’s latest inflation data suggests there is a severe risk of continued deflationary pressure. According to the local statistics bureau, Japan’s latest inflation data (preliminary January 2016) came in at 0.2% YoY. In the release, the largest drop was “all items, less food (less alcoholic beverages) and energy” (similar to our definition of core inflation) which had a -0.1% monthly change. In the Ku-area of Tokyo, this difference was much more significant at -1.0% YoY. On a similar note, Japanese wages barely grew in 2015, rising a mere 6 bps. With this kind of data coming in, the BOJ had to make its move—bringing interest rates into negative territory.
The significant difference in headline vs. core inflation data is a key variable the BOJ looks at when adjusting policy. Short term forecasts by the BOJ aim for inflation to average 0.2-1.2% by April 2016 to March 2017, despite BOJ Governor Haruhiko Kuroda announcing his goal of 2% by late 2016. Given the recent disappointing data, market participants are doubting the probability of achieving this target, writing it off as talking up inflation expectations. In response to this data, the BOJ appropriately took the next drastic move to prevent a deflationary spiral. Contrary to this development, officials in Japan are currently contemplating contradicting monetary policy with tightening fiscal policy.
Japan’s inflation goals could be trumped by a planned increase in sales tax. Deficit hawks are suggesting that Prime Minister Abe should move forward with his planned sales tax increase of 8% to 10% next year. Communicating this delay or intent to remain on schedule will be a key variable going forward for the Japanese Government Bond (JGB) and FX markets. JGB traders and hedgers seem to be worried about the country being able to eventually pay off its massive liabilities. Japan has one of the highest debt to GDP ratios amongst developed nations. According to Bloomberg’s iTraxx Credit Default Swap Monitor, Japanese credit protection has moved up 33 bps in the last 3 months—8 bps just this week on the back of underwhelming inflation growth, chatter of delaying more responsible fiscal policy, and bearish equity returns.
The fiscal and monetary policy landscape for the U.S. and Japan are very different in terms of their aggressiveness. Both have, however, been overly accommodative in the wake of the financial crisis. Time will tell if the U.S. experiences a “Japanese-esque” lost decade. Slow growth, low inflation, and negative rates are a close or realized reality now for some of North America, Asia-Pacific, and the European Union. Even countries that seem to be on the road to higher interest rates organically are weary of slipping back into a recession due to a real global backdrop. William C. Dudley, the president of the Federal Reserve Bank of New York, recently indicated the U.S. would too consider negative rates should the economy continue to weaken domestically. While unlikely according to Fed fund futures, it is still a possibility.
CEO, Elite Wealth Management
Full Disclosures: http://elitewm.com/disclosures/
This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.