Will The Abenomic Success Continue?

Last year, when details of Abe's new economic policies were coming together, the experts scoffed. After all, the Japanese economic managers had been trying a beta-light version for many years. Keynes had to have it wrong. The last twenty years of deficit spending had resulted in a strong currency, a moribund economy, deflation, and, an ever-growing level of sovereign debt.

This would merely be another verse to a familiar old tune. The past expansion of the yen supply did have results, but this time it would be different because there were to be positives. But with sovereign debt already 240% of the GDP, how would Abe succeed?

Much has been accomplished during the first year. Of major importance was the installation of the Bank of Japan's Governor Kuroda. With Abe and Kuroda reading from the same economic page, expansion of the yen supply was more easily obtained.

The increased money supply helped end years of deflation, but the inflation was not the beneficial type. For October, Japan's consumer price was up 0.9%, led by fresh food and energy costs. Missing from the number was increased consumer confidence and higher wages.

Abe did successfully weaken the yen with mixed results. The weakening of the yen aided the export recovery and the anticipation of further yen strength buoyed the equity markets. The elevated yen raised the price of energy the Japanese need to import.

Compared to the USD, the yen has weakened significantly. In November, when the economic plans were first being announced, the yen was slipping from a high of about 79 per USD to 83 by month's end. The weakness continued through May with the yen selling down to 1.0350 yen for a USD.

Since the May rally faded, the pair has been consolidated in a narrowing range. Three weeks ago the USDJPY again broke to the USD's upside and we are currently trading at 1.0240, with the market acting like there might be another 100 pips on this run.

USDJPY Weekly Currency Chart

(click to enlarge)

Abe's plan has been more than just money printing - he has also advocated capital spending, production reforms and high taxes to close the deficit. Rice production is being cut 260,000M/Ts and there are going to be tax increases in April. To compensate for the negative effects of the higher tax, the government is working on a package of off-setting stimulants. It is hard to see how all this will work out.

Throughout the bear yen moves for the last year, specs have held large short positions. The most recent COT report showed a record short, 155.1K. Going back to December 2012, their short position was 141K. When the bear move paused in May, the specs were short 130.8K. Recent market action has obviously added to the bears' profits.

Abenomics is more than just monetary stimulus and money printing, however. They also intend to incorporate fiscal stimulus and some structural reforms. Among the projects earmarked for structural reform include:

• Move 10 Japanese universities into the global top 100 - today there are only two.


• Join the Trans Pacific Partnership with the aim of increasing Japan's international trade under free trade agreements from 20% to 70%.


• Promote inbound tourism.


• Split electric utilities generation and transmission business and break up utility monopolies.


• Allow and encourage cities to experiment with deregulation measures.

The list of potential structural changes is certainly a worthy goal but achieving it is not easy. At a time, however, when the Washington regulatory policies are increasingly intrusive and obstructive to the US private sector, we are inclined to think the Japanese reforms are far more beneficial to Japanese industry than those being started in the US that are helpful to US business. Continuation of this trend may prove more yen-beneficial versus the USD.

A potentially overlooked facet of the Japanese economy may be the rebuilding of Japanese military. Since WW2, the American military had been the defender of Japanese territory. Recent squabbles between China and Japan over ownership of islands in the East China Sea seems to be getting worse.

It is hard to determine China's intentions but should this bellicose behavior grow, so does the risk of a mistake or miscalculation. At a time when US foreign policy is dovish and likely to be tested, this would seem to again be bearish the yen. Should the East China Sea tensions expand, this would serve to weaken the yen, though it might also be USD bearish.

The yen market is loaded with bears but they have profits and do not have reasons to exit the market. We would expect some resistance in the 1.0350 area in the USDJPY. East China Sea issues could easily result in further yen weakness but there is a possibility some of the specs may lose interest in the USD and rather buy the euro instead.

EURJPY Weekly Currency Chart

(click to enlarge)

The euro has had a big move already, from 1.25 to over 1.39 against the yen. Should the pace of the winds of hostilities increase, where will the EURJPY trade?

As always, manage your money.

Source: Will The Abenomic Success Continue?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. (More...)

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