Ichiro Suzuki
In early August, Japan’s stock market had suffered an epic decline, in part due to jitters in the U.S. A 12.5% fall on August 5 marked the second worst day in history, only after a 14.5% fall on October 20, 1987 that followed the Black Monday on Wall Street. On the previous Friday, August 2, the S&P500 suffered a sharp loss in response to the July job report that undershot expectations, and kept falling on Monday.
A thriller this summer had originated in the Bank of Japan’s intervention in the foreign exchange market, in order to stem the yen’s relentless fall. Prior to the volatility spike, global financial markets were rising steadily amid eerie quietness. Selling the yen looked like a sure bet. Interest rate differentials between the U.S. and Japan had been so wide for so many years. The two central banks’ next moves would narrow the differentials but they would still remain very large to justify continued buying of the greenback against the yen. It looked so safe. Then, the MoF intervened in the market in July rather unexpectedly.
Then, on July 31, the Bank of Japan raised its interest rate by 0.25%. The quarter percentage point hike was the first one since 2007. At a press conference that followed the action, governor Kazuo Ueda hinted a further hike in the future, amid rising prices that were in part attributed to a weak currency. There might have been a pressure on the BoJ from politicians to do something about inflation though the central bank is independent in theory. Governor Ueda’s remark sounded more hawkish than expected, and spooked the market.
Two days later, the U.S. July job report failed to meet expectations. After all, it was far from a disaster that hinted an imminent recession. Following the BoJ’s actions, however, the market participants had decided to take it more bearishly and sold stocks on Wall Street. Selling continued at the beginning of the following week. A sudden risk-off sentiment spread to the rest of the world.
The Nikkei index had suffered a sharp 24.5% fall in a matter of less than a month, In contrast, the S&P500 was down only 8.5% from its all time high in July. Less than a double digit fall was within a range of a normal correction from a temporary overbought level. During the four week period of rising volatility, the yen rose sharply, for a double digit gain against the dollar. The yen has considerably mitigated the Nikkei’s negative returns for U.S. dollar based investors. For Japanese yen based investors, on the other hand, these four weeks were brutal. The best asset on earth was Japanese yen cash that yielded close to nothing at a time when the value of their foreign equity investments was down for Japanese investors due to the yen’s rise on top of share price corrections. They have seen this before, most recently in the early years of the 2010s when excessively richly valued yen was exerting downward pressure on prices and the Japanese economy, and returns form risk assets were hopelessly low, if they were positive.
PM Shinzo Abe fiercely fought the Japan disease in the 2010s to root out deflationary pressure and absence of growth with aggressive fiscal expansion and injection of liquidity. Revitalized growth, to some extent, and weak yen brought cozy times for Japanese investors. This four week period of a summer of discontent, however, was a reminder that the Japanese economy could be quickly brought back to a nightmarish time of deflation and too strong yen.
The summer thriller was a proof that ‘Abenomics’ was incomplete. PM Abe’s economic policy consisted of three arrows: fiscal stimulus, monetary easing and restructuring of the economy. Of the three, the first two were done very aggressively and quickly. The last arrow, however, was never shot in earnest. Restructuring is easier said than done, since it causes short-term pains with a large number of job losses in the sectors that are inefficient and uncompetitive. In Japan or elsewhere, politicians are often unwilling to tackle the root cause of economic malaise because greater job losses reduce a chance of reelection. Labor market reform has always been desperately needed but only half-hearted one was delivered. PM Abe tried to tackle it once but failed in it amid fierce opposition from the left, with which the public opinion sided.
The Japanese economy performed well in recent years, in part assisted by weakening of the yen, which boosted corporate profits and hence employment. When the currency’s weakness went too far, causing greater imported inflation, it became a too much of good things, and that had to be corrected as politicians shouted. The Japanese market might have showed a different reaction if the economy wasn’t too dependent on American consumers. Without genuine domestic demand carrying the economy, the Japanese economy may have to oscillate between inflationary pressure under a weak yen and deflationary pressure under a strong yen.
About the author: Mr. Suzuki is a retired investment banker based in Tokyo, Japan.
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