An anomaly or the new normal?
The below graph reflects Japan’s accelerating trade deficit. February showed a large spike in imports over exports—the biggest gap in its recent history. This article considers the outlook for Japanese markets as its trade deficit starts to accelerate under the weakening yen and unprecedented monetary policy initiatives.
Too much too fast?
The above graph might suggest that Japan’s trade deficit is growing a bit too quickly. While Japan’s current economic policies are essentially intended to weaken the yen, and to eventually support domestic exporters like automakers, one tends wonder if these policy objectives can go too far too fast. As discussed earlier, the near-term impact of the weakening currency can reinforce near-term import decline. However, if Japanese consumers feel that wage growth is on the way, they may continue to consume at strong levels. This year saw Japan’s first growth in wages since the 2008 crisis, with an average gain of 1.5%.
Japan’s 2014 Shunto success, wage gains in Japan will support growing deficit
Japanese unions manage to negotiate a 2.1% average growth in wages for 2014—the first since the 2008 crisis. With record corporate profitability in Japan, perhaps the raise was long overdue. This could be a major victory for Japan’s newest Prime Minister, Shinzo Abe, as he has sought to make good on his mandate to improve the lives of the Japanese workers. Plus, through aggressive monetary and fiscal policy, Abe, in conjunction with Japan’s central bank, has sought to exit deflation, and achieve a 2.0% inflation target. Given the slated wage growth for 2014, Abe has scored big on wages and hit his goal. As the above graph reflects, the growth in the trade deficit could reinforce these inflationary pressures in Japan. While skeptics focus on the near term negatives of import price tag shock, long-term constructive views can find support in these reflationary gains.
The Japanese yen
The key barometer of these reflationary developments will be the Japanese yen. Should Japanese domestic investors become convinced that inflationary pressures will take root and continue to grow, a significant landslide in selling yen to buy dollar-denominated assets could gather momentum. This would be a watershed event for post-1990 Japan. While Japan has seen three 20% plus weakening bouts since 1997, the current weakening stretch of over 30% is large, and given the monetary and fiscal measures noted above, can prove to be the largest and longest sustained period of yen weakening.
To see how trade and foreign exchange dynamics affect Japan’s real GDP growth, read the next article in the series.
For an overview of the April 1, Bank of Japan Beige Book on Japan’s economic outlook, read Bank of Japan Tankan supports a 2014 equity rally in Japan.
Japan’s equity outlook
As 2014 progresses, investors could see a continued outperformance of Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan ETF (EWJ) versus China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). For further clarification as to why DXJ could outperform both EWJ and other Asian equity indices, read Why Japanese ETFs outperform Chinese and Korean ETFs on Abenomics. Plus, as Japan pursues unprecedented monetary expansion, and the U.S. Fed tapers its bond purchases, Japanese equities could also outperform the broad U.S. equity indices, as reflected in the State Street Global Advisors S&P 500 SPDR (SPY), State Street Global Advisors Dow Jones Index SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV).