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Japan: The Yen, Abenomics, and Portfolio Flows

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Prime Minister Abe now says he will not be pushing labor reforms in the next policy package.

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The US dollar is recovering after briefly moving below its 200-day moving average against the Japanese yen for the first time since last November. The low, just below JPY96.60, was seen prior to the opening of Tokyo markets.

By the end of the Asian session, the dollar was consolidating in the JPY97.00-20 area. Although the dollar has not maintained its early upside momentum in North America, we think risk-reward pays to be long the greenback, with stops below JPY96.50.

News from Japan largely consisted of the August current account figures. The smaller-than-expected surplus was largely a function of the reduced investment income (interest payments, dividends, and to a less extent, royalties and licensing fees).

With the current account figures, Japan also reports a country breakdown of portfolio flows. In August, Japanese investors bought JPY277.7 billion of foreign bonds, which is a sharp reduction from the JPY3.453 trillion (~$36 billion) bought in July. US bonds remain far and away the favorite foreign market. Japanese investors bought JPY707.3 billion in August after devouring JPY2.701 trillion ($29 billion) in July.

That means that Japanese investors were net sellers of the rest of the world's bonds. The largest selling was seen in France. Japanese investors sold almost JPY195 billion of French bonds, paring the JPY583.7 billion bought in July. While Japanese investors have generally favored French bonds, this is the first time they have been sellers in two of the four months in two years. Japanese investors also sold UK bonds (JPY133.70) for the third consecutive month and have only been net buyers of UK bonds in two months since June 2012.

Japanese investors have been scaling back on their Australian bond holdings since last November. They turned buyers in July for the first time, but returned to the sell-side in August (JPY82.1 bln). This coupled with the light sales in June (JPY9.8 bln) offsets in full the JPY91.3 bln purchased in July.

Japanese investors were net buyers of foreign equities, albeit a minor JPY4.6 billion, in August, the first time since June 2012. Over the 13-month selling spree, Japanese investors sold about JPY6.88 trillion of foreign shares (~$71 bln). Japanese sold almost JPY48 bln of US shares, followed by JPY24 bln of UK equities and JPY23 bln of Australian stocks. They were net buyers of JPY39 bln of Swiss shares, the first net purchases since July 2012. Japanese investors were more modest buyers of French and Dutch shares (JPY17.10 bln each) and buyers of Korean shares (almost JPY12 billion).

The lack of significant portfolio capital outflows from Japan is likely a disappointment for the architects of Abenomics. Indeed, although heralded as a major success, the limitations of Abenomics are becoming clearer. It rests primarily on government spending and the Bank of Japan stimulus. Business and investor support has been lukewarm. Capital expenditures have disappointed, and this was underscored by the September Tankan survey that found somewhat lower overall planned expenditures than anticipated in June.

The yen has weakened, but bottomed more than four months ago against the dollar. The weakness of the yen is helping lift imports faster than exports. This is producing persistent trade deficits, which are fairly stable (3-month average deficit JPY724.7 billion and the 12-month average JPY797.2 billion).

This also helps explain the inflation that Japan is experiencing. It is largely a function of imported energy, which when excluded, suggests deflationary forces are still present.

Prime Minister Abe now says he will not be pushing labor reforms in the next policy package. He is apparently meeting too much resistance to relax the traditional job protections. However, workers are being squeezed by the lack of base wage increases, higher inflation, and coming soon, a higher tax on consumer purchases.

The stimulus package announced to offset the retail sales tax hike did not include a corporate tax cut, but it is clear that Abe is sympathetic as the Japanese schedule corporate tax rate is 38%, well above most other high income economies. In negotiations in the coming months, it would not be surprising to see the effective corporate tax burden reduced.

See more from Marc Chandler at his blog Marc to Market.

Twitter: @marcmakingsense
No positions in stocks mentioned.
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