Get set for QEverywhere!

“one area though where Abenomics has undoubtedly failed is that the Bank of Japan has not achieved its 2% core inflation target. When the BoJ started QE in April 2013 they stated that they wanted to hit their 2% inflation target for core CPI at the earliest possible time, with a time horizon of about two years?. Well that is now! Yet most key measures of CPI inflation are set to crash to, or even below, zero in the months ahead as the estimated 2% effect of last year’s VAT hike is set to drop out of the yoy calculations. Core CPI inflation that the BoJ targets, which excludes just fresh food, has been running at 2% yoy in February (March data out this Friday). But I prefer to focus of the readily available CPI ex food and energy (known in Japan as core core CPI), which for some peculiar reason does not get followed that closely by the market. At the same time as the March national CPI is published, April’s CPI data for the Tokyo area also will be released. The headline and core (ex fresh food) CPI will be just above zero yoy. But the core core Tokyo CPI (ex food and energy) is likely to have dipped below zero as VAT drops out as the rate in March was already only running at 1.7% (see chart below).

Regular readers will know that I am pretty horrified by the global Quantitative floodgates that have been opened since the 2008 Great Recession. Once an emergency measure of dubious effect, it is now a never ending stream of confetti money being thrown around the world to inflate asset prices. QE has now become the policy variable of first resort. Personally I think this will all end very badly. But why, I often asked, am I so much more positive about the Japanese outcome than I am the US, UK or eurozone?

To be sure I would agree with the Japan sceptics like my former colleague Dylan Grice, John Mauldin and Kyle Bass. But I am bullish because I believe that the Japanese fiscal situation is so bad that the authorities had no option but to begin their QQE in April 2013 and there is indeed, as Peter Tasker says, no turning back. Russell Jones is also correct that the BoJ will become more and more aggressive and inventive for the simple reason that Japan is bust.

Personally I have little doubt in my own mind that the Japan government is bust. Many other countries are too, but Japan is much further down the road. Japan’s lamentably low trend growth rate means it cannot possibly pay off its 260% of GDP debts (or even its 140% net debt). That is why it needs to default. That is why it needs to create inflation. And that is why, as John Mauldin puts it, Japan is a bug looking for a windshield. The easiest way of demonstrating the Japanese government problem is the chart below which shows just how massive Japan’s avalanche of bond issuance was in 2013. The problem is not the ongoing deficit at 10% of GDP (now down to 7% of GDP). It?s about the rapid roll-over of existing debt with a short average maturity, which means that the government has to come to the market with near 60% debt issuance relative to GDP each year (apologies for not updating the chart but it still makes the key point). That is why there is no alternative to QQE in Japan.

Ultimately the pressure point remains the yen and in a currency war race to the bottom I have little doubt that Japan will be the unintentional winner. Our bold end March forecast of Y145/$ may have been missed (I was advised at the time never to give a point forecast with a date attached), but once we break the key Y122/$ multi-decade support level I think we will get to Y145 in a flash. With CTFC data showing speculative net shorts in the yen at the lowest level since QQE was mooted in the autumn of 2012, and with the market having moved sideways between Y118-122 since the start of December 2014, the speculative and technical excess has been unwound, readying the currency for another major move. Most likely the trigger will be another surprise BoJ move…

So while the US may be on a verge of a recession that will shock markets, Japan is just exiting its third downturn since the 2008 Great Recession, with a new round of QQE beckoning and a wage/price spiral now within the BoJ and Abe?s grasp (whatever its merits). Personally, like Dylan and the sceptics, I believe the Japanese authorities will probably lose control of the inflationary situation and that is why I am so bullish. In that context we must highlight our 2010 note calling for the Nikkei to hit 63,000,000. Who says I’m an über bear?

The Q1 US GDP data was a major disappointment to the market as business investment declined due to the intensifying US profits recession. Only the biggest inventory build in history stopped the economy subsiding into a recessionary quagmire. The US economy is struggling and the Fed will ultimately re-engage the QE spigot. Talk is growing that China will soon be doing the same as local authorities struggle to issue debt.

…Low growth (and inflation) to prompt more QE – everywhere!