Abe goes all-in

The market is evidently coming to grips with the latest Japanese GDP "shocker", as is the political establishment.  Japan has such a long and (in)glorious history of freakish data out-turns that it is difficult to be truly flabbergasted by yesterday's number, particularly as it was largely driven by inventories.   Nevertheless, the data was clearly very disappointing, and if you're keeping score at home, the economy has now shrunk by 1.8% in real terms since Shinzo Abe took office.  As an aside, in real terms the economy is now smaller than it was when Abe was unceremoniously booted from office the first time, in September 2007.

On the face of it, therefore, one can question how effective Abenomics has really been.   To be sure, the imposition of the consumption tax hike is a massive qualifier which dented the momentum that Japan's economy built up last year.   That having been said, following the previous VAT hike in 1997 the economy rebounded strongly in Q3, more than recouping the pullback in Q2.  While it's true that the global economy is on a weaker footing than 17 years ago, it's not like it was all pony rides and lemonade back then, either: Asian crisis, anyone?

That's not to say that Abenomics has been totally ineffective, of course.   USD/JPY's 50% higher than it was before Abe took office, and the Nikkei has more than doubled.  That's good news for most exporters, equity holders, and pajama-clad retail FX punters; in a familiar theme to those in the West, it's less clear that the beneficent impact of these asset price moves has filtered down to Main Street.

Abe's response?  Well, it's one that many members of the FOMC and non-Germanic ECB board members could appreciate: clearly we haven't done enough!

The BOJ knocked the market's socks off with its QQE decision at the end of last month.   Recent declines in prices, particularly for energy, evidently gave them ample cover - recall that there is a negative impulse from yen weakness as it pushes up energy costs, which Japan's legions of pensioners are rather sensitive to.   A nearly 25% decline in the yen price of Brent since earlier this year may have afforded Kuroda an opportunity to up the ante.

However, it's worth noting that even at the current price of Y9500 or so, oil is still very expensive by historical standards.   Pushing the yen weaker is not an obvious panacea in that regard.

The asset allocation shift of the GPIF will create plenty of demand for domestic equities and a supply of yen as the institution buys foreign assets.  As this happens, the music may well play on.   After the fact, however, the GPIF will be taking very much more investment risk than they are accustomed to.   Perhaps this will not be an issue; US pensions and endowments have certainly ridden a roller coaster over the past decade or so in terms of their investment returns, albeit generally on nothing like the scale that the GPIF operates in.  That having been said, it is probably worth asking the question about what would happen should 2008-type price action (or even 2002-type price action) occur; the GPIF would almost certainly be sitting on monumental losses.   Perhaps this attempt to kick-start the economy is worth this risk; then again, maybe it isn't.

Finally, Abe is now calling a snap election just two years after he was swept into office, presumably to freshen his mandate to throw even more lighter fluid on the searing rallies in USD/JPY and the Nikkei.  His decision to postpone the next VAT hike for a few years, while probably wise, will nevertheless not please either the mandarins in the MOF or Kuroda (the recent aggressive easing was presumably a quid pro quo for staying the course on VAT hikes.)

Should Abe's LDP win another sizable majority, one would have to presume that the asset allocation shift will continue apace, maintaining a tailwind for recent trends.  That having been said, on a structural basis Macro Man is a little wary.   Price action in the Nikkei, for example, is strikingly similar to that during the time of the last "revolution" in Japan, i.e. the Koizumi administration.

Needless to say, that didn't end well.   Macro Man can envisage USD/JPY trading back up to the low 120's but is sceptical that it can extend much further.  Political tolerance elsewhere in the world for much more yen depreciation has to be called into question, particularly in the context of a global growth deficit.   Moreover, thanks to years of Japanese deflation the PPP marches steadily lower, and 125 today is a much weaker yen than it was 10 or 15 years ago.

Still, in the near term it's hard to fight the trend, particularly when the policy levers on both sides of the trade appear supportive.   Nevertheless, it's worth remembering that one-way bets in the yen usually end not with a whimper but a bang.

Not that Abe will mind, of course.   If he gets chucked out of the PM's office again, there will no doubt be a warm welcome for him at the Eccles building.   After all, if Koizumi can impersonate Elvis, why can't Abe mimic Janet Yellen?