Friday, 18 October 2013

Japan's Campaign to Eliminate Deflation Begins

Ralph Shell, Excel Analyst

Finally, the fretting about the US government shutdown is over, and the market can look for new concerns.  It looks, from Thursday's market action following the vote in the US House of Representatives, that a settlement had been priced in to most of these markets, so there were no surprises. 

The naysayers claim it was a feeble kick of the can down the road.  This risks another shutdown in two or three months.  This, however, is unlikely for several reasons. 

First, Senate minority leader Mitch McConnell says "a government shutdown is off the table" this winter.  Second, Congressional Republican leaders are aware that, as in 1996, the Fourth Estate sided with the Democrats,  Then, continually accusing Newt Gingrich of withholding the money for school kids' lunches, the Republicans lost that PR battle. Shutdowns will best be avoided until after the 2016 elections, even though the debt limit will need to be increased again.

After passage of the bills that enabled re-opening of the small part of the government that had been closed, and the debt limit increased, the USD's strength was brief.  Rumors that the shutdown would result in a GDP reduction may have caught the crowd by surprise.  If there is a possibility the economic numbers will reflect economic contraction, chances are the Central Bankers are going to postpone any tapering until Yellen takes office next year.

The yen has had some interesting moves, in part because because of the relationship to the USD.  In anticipation of the shutdown possibility, the yen fell from about 99 to 96.60.  Then, as optimism of a US debt agreement materialised, the safe haven demand disappeared and the yen slipped to about 97.90 before reversing Thursday. 

Click to Enlarge USDJPY Daily Currency Chart

This comes at a time when PM Abe has convened the Diet for an extraordinary 53-day session.  Earlier, he had decided to go ahead with the increase in the consumption tax from 5 to 8% beginning in the spring of 2014.  To prevent that from being a drag on the economy Abe is looking for offsetting stimulative measures. 

The main objective of this session will be to pass bills that will help fight the chronic deflation.  An example of a proposed policy that might help is to reward companies those companies that share their wealth by increasing wages and salaries to their employees;  Toyota has seemed receptive to such a plan. 

To get business to co-operate with wage increases Abe is debating a reduction of corporate taxes.  Currently, the Japanese corporate rate is 38%, high, but less than 40% in the US, which is the world's highest.  The new proposed Japanese rate would be between 25 and 30%, still higher than the global average of 24%. 

Another part of the discussion is taking back responsibility for their own defense. 

According to newsonjapan.com:

"Abe will also push ahead with a bill to set up a ministerial council to help quickly respond to foreign and security issues, apparently considering the security environment in Northeast Asia, where North Korea's nuclear and ballistic missile ambitions and the assertive maritime policy of China remain of concern."

Absent from this report is an explanation why the Japanese, at this time, now wish to take some of the responsibility for their own defense.

We prefer to have current knowledge of the latest COT report prior to establishing new positions.  The last report we have is quite dated (September 24th), which means the last two weeks of trade is missing.   On that report specs were quite short, almost 128K.  We are inclined to join the army of short sellers, but only if they have bailed on some of their positions. 

Click to Enlarge USDJPY Weekly Currency Chart

Our longer views on the yen versus the USD remain bearish but we wish to wait for a better entry level.
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