Japan and the yen seem sidelined. Japanese markets were closed for the first half of the week for the Golden Week holidays. The weakness in the US economy and the concurrent doubts about Fed tightening this year, coupled with the dramatic reversal of euro zone assets after strong gains in Q1 have kept traders and investors focused elsewhere.
Nevertheless, there are two important developments in Japan. First, it seems still under-appreciated what the Bank of Japan did before the Golden Week celebration. It moved its goal posts. At its last meeting, it indicated that it no longer expects its inflation target to be met "in or around" the current fiscal year. It now says it will be met in the first half of FY 2016 (April-September 2016).
The BOJ knows what all central bankers and investors know, which is that when last year's dramatic oil decline finally drops out of the year-over-year comparison, its measures of inflation will rise. The BOJ targets the core rate of inflation. Unlike the US measure, Japan's calculation excludes fresh food but includes energy.
Nevertheless, the new time frame looks ambitious. In addition, it repeats the tactical mistake of the past target. Other central banks target medium-term inflation, not a 12-month or 18-month objective. The proximity and precision do not in themselves boost credibility. Instead, they puts it at risk by forcing it to make unnecessary decisions.
By moving the target date but not announcing more stimulus, the BOJ may be sending an important signal. It is looking through the recent fall in its inflation measure to zero in February before firming to 0.2% in March. The disposition of the Board of Governors, especially with the recent personnel changes means that a decision to boost asset purchases would get a more favorable hearing than the 5-4 vote last October.
However, it seems that the bar to additional stimulus is higher than many appreciated. Reports suggest that many banks that had been looking for increased BOJ efforts by July have pushed it out to October. The bar here is also likely to be moved out rather than in.
The second important development is the government's increasing reliance on moral suasion to fulfill Abenomics. Abe has accidentally discovered the truth behind one of the old English proverbs: You can lead a horse to water, but you can't make it drink. The policies of the Abe government have weakened the yen, lowered interest rates and boosted corporate profits. However, the benefits have been too concentrated.
Prime Minister Abe has stepped up his moral-suasion campaigned aimed at businesses. Last year, he led a charge to encourage businesses to embrace shareholder values more. This included, for example, having external board members. Japanese officials from the METI and the MOF regard this as a successful effort.
Now he wants them to do two things. First, working through the business association (Keidanren), the government is encouraging big businesses that have benefited from the yen's weakness to share some of the windfall with suppliers who have been squeezed by accepting higher prices. While officials may coax a couple of examples, it is difficult to envision widespread implementation. That said, commodity prices are beginning to rise and suppliers may have to raise prices regardless of the government's initiative.
Second, Abe is lobbying businesses to boost their domestic investment, which is understood widely to include real wage increases. There has been some high-profile success. Wage increases, especially in the auto sector, have been reported. While the results of the spring wage round are still being awaited, the official data suggests that up until now, wage growth has been meager despite measures pointing to a tight labor market.
Capex plans are also weak. Japanese businesses seem more inclined to place new investment outside of Japan. However, there have been some reports indicating that some auto producers are bringing back a small amount of production back on-shore as the yen's weakness boosts Japan's competitiveness.
Beyond the moral suasion lies the threat of government action. Former Prime Minister and now Finance Minister Aso says that unless Japanese businesses cooperate, a tax on retained earnings should be considered. We have discussed this with Japanese officials, but there was always an understandably firm pushback. That Aso said "should be considered" implies that, (a) it is a threat as (b) is it is not presently being considered. It is a reminder of the power of the state.
Turning to the yen, we have often remarked that the dollar-yen pair is largely a range-trading instrument. And when it looks like it's trending, it is frequently moving to a new range. For the better part of six months, the dollar has been in a range against the yen. The broad range is JPY116-JPY122. Within it, a narrower range has dominated over the last few months: JPY118.30-JPY120.80. We are more inclined to see the dollar (eventually) break higher out of the range rather than lower.
The Nikkei has retreated by about 5% since peaking above 20,000 on April 23. It is up about 10.5% year-to-date. With the BOJ and many pension funds still buying Japanese equities, continued extraordinarily easy monetary policy and an economy that is expanding (around 1.5% in Q1, GDP due May 19) the pullback in stocks looks corrective. The Nikkei tested the 19,260 area earlier Thursday as local investors returned from the holidays. Initial support is seen in the 18900-19000 area. A break would likely signal a bonafide correction (10%) and bring the index into the 18000-18500 range.