With all the high-profile events in America and Europe hogging headlines in publications we follow, Japan may be easy to overlook. But we think it remains an important consideration for global investors as the world’s third-largest economy and because of its sizeable chunk of developed markets.[i] Take a look at how Japanese inflation (economy-wide price increases), monetary policy and gross domestic product (GDP, a government measure of national output) are faring in the Land of the Rising Sun.
Wages Lag Inflation in Japan, Too
Japan’s annual spring shunto wage negotiations between labour unions and management show rising labour costs are an aftereffect of inflation, in our view, not necessarily a prelude to an escalating wage-price spiral. Last Thursday, UA Zensen, the country’s largest union organisation representing 240,000 workers, secured a 5.28% wage hike to keep pace with 4.4% y/y inflation—following similar deals major automakers made with their workers.[ii] This year’s hike followed last year’s 2.2% raise, which was the first increase in four years.[iii] For some broader context, consider: Before this year, annual raises didn’t exceed 3% since 1997—with no base-pay hikes until 2013.[iv] Consumer prices were deflationary much of this time, so meagre nominal wage gains were enough to pump real (meaning inflation-adjusted) wages.[v]
We think this shows past inflation impacts wages, as it took the recent pickup in inflation to drive larger increases. But past prices don’t predict. Companies’ paying workers more doesn’t suddenly mean they can (or will) then turn around and raise their prices an equivalent amount, in our experience—that depends on supply and demand in their chosen markets, and we think wages are incidental to this. Economic conditions could still force firms to cut prices to clear inventory, for example, no matter how much they raise wages.
Whether in Japan or elsewhere, the data we observe show wages don’t drive inflation—they trail it. No surprise then that long-term Japanese market-based inflation expectations haven’t budged above 1% despite supposed wage pressures building.[vi]
New Governor, New Monetary Policy?
After receiving legislators’ blessing last week, Kazuo Ueda will officially succeed long-serving Bank of Japan (BoJ) Governor Haruhiko Kuroda on 8 April, as speculation swirls over the BoJ’s monetary policy direction—and what that means for markets.[vii] Alongside Ueda, Parliament also confirmed two new BoJ members, which we think highlights the difficulty in predicting how any rotating cast of characters—all with their own unique opinions and biases—will vote.[viii] Instead, we think it best to assess decisions when they come. No need to agonise over potential changes to monetary policy beforehand, in our view, especially since: 1) the economic effects tend to hit at a 12 to 18 month lag, and 2) the market impact isn’t predetermined.
That said, the BoJ’s quantitative easing (QE) asset purchase programme, negative interest rate policy (NIRP) and yield curve control (YCC) programme of setting targets for 10-year government bond yields are worth monitoring to us. All have been counterproductive to growth, in our view—yet most commentators we follow still portray them as accommodative. The BoJ was the first monetary policy institution to implement QE in 2001, buying Japanese government bonds (JGBs) to suppress long-term rates.[ix] QE expanded after Kuroda took the helm in 2013 to include corporate bonds and even stocks.[x] But our research shows QE shrinks banks loans’ profit margins by narrowing the difference between their short-term funding costs and longer-term loans’ interest income. We think that has reduced Japanese banks’ incentive to lend, not spurred it.
As we have written before about other central banks’ NIRPs, the theory they induce more lending hasn’t worked in practice based on our observations. NIRP is effectively a tax on banks’ reserves, theoretically penalising idle funds held at central banks unless they back new loans.[xi] But the BoJ’s early-2016 NIRP squashed long-term interest rates more, further shrinking the spread between short and long-term interest rates.[xii] With lending even less profitable, loan growth stagnated.[xiii]
Late 2016’s YCC was the BoJ’s attempt to remedy this.[xiv] It targeted a 0% 10-year JGB yield (manipulating the shape of the yield curve, which is a graphical representation of one issuer’s interest rate across all maturities, hence the name), which was higher than where yields were trading at the time, prompting the BoJ to taper QE and let long rates rise.[xv] But we have found over the last year, as other major central banks ditched their QE programmes and developed market yields outside Japan rose with inflation, near-zero JGB yields increasingly became an outlier—and untenable. The BoJ has given some ground, widening the YCC band it defends to half a point in late 2022, after which 10-year JGB yields immediately shot up to 0.5%.[xvi] But even with this, we observe YCC continues pulling long rates down instead of letting them rise.
We found it somewhat encouraging Ueda acknowledged these policies’ side effects in his confirmation hearing, but we don’t think that predicts what the BoJ will do. However, wider recognition of their pitfalls opens the door to potential remedies. If and when they develop, investors are better off being aware of them.
How Is Japan’s Economy Muddling Through It All?
Last Thursday, the Cabinet Office revised its Q4 Japanese GDP estimate down to 0.1% annualised growth (rounding to flat on a quarter-over-quarter basis) from its 0.6% initial estimate—which follows Q3’s -1.1% contraction.[xvii] The downgrade came mainly from household consumption’s revision to 1.3% annualised growth, down from its 2.0% preliminary reading.[xviii] Business investment fell -2.0% annualised, easing modestly from the previous estimate’s -2.1%, whilst trade’s positive contribution largely offset it, as exports notched their fifth straight quarterly gain.[xix] Meanwhile, residential investment was revised up to flat from a -0.5% annualised decline.[xx] Private domestic demand components—combining residential investment, capital expenditures and consumer spending—fell to -2.3% annualised growth from the -1.5% first estimated.[xxi]
So, like most of the developed world (eurozone’s Q4 GDP growth was also revised downwardly to flat last week), we find Japan’s economy is mixed under the bonnet.[xxii] But whilst domestic headwinds continue to weigh, they seem widely known at this point, in our view. With external demand appearing to be a more consistent growth engine to us, we think having exposure to multinationals with greater ties to the world economy is likely more beneficial for investors seeking global diversification in Japan than focussing on domestically orientated companies. More broadly, with Q1 soon coming to a close, Q4 data are far in the rear-view for forward-looking stocks, and more recent data suggest improvement.
Japan may not stand out in today’s news cycle, and its returns have long been lacklustre.[xxiii] But we don’t think it wise to look past one of the world’s major economies, as there are opportunities for global investors with a selective approach.
[i] Source: FactSet, as of 16/3/2023. Statement based on Japan GDP as a percent of world GDP, Q4 2022, and Japan market capitalisation as a percent of the MSCI World Index, 14/3/2023. Market capitalisation—share price times number of shares outstanding—is a measure of market value.
[ii] Source: FactSet, as of 16/3/2023. Japan consumer price index, January 2023. “Japan’s Largest Union Group Clinches Pay Deal Exceeding Inflation Ahead of ‘Shunto’ Day,” Tetsushi Kajimoto, Reuters, 9/3/2023. Accessed via Yahoo!
[iii] “Explainer: Why Japan’s ‘Shunto’ Spring Wage Talks Matter,” Tetsushi Kajimoto and Leika Kihara, Reuters, 7/3/2023. Accessed via Yahoo!
[v] Source: FactSet, as of 16/3/2023. Statement based on Japan consumer price index, January 1997 – January 2023.
[vi] “Japan’s Non-Inflation Scare,” Tom Nemechek, Advisor Perspectives, 23/2/2023.
[vii] “Ueda Gets Green Light to Take Over BOJ’s Challenges From Kuroda,” Toru Fujioka, Bloomberg, 9/3/2023. Accessed via Yahoo!
[ix] “Minutes of the Monetary Policy Meeting,” Staff, BoJ, 19/3/2001.
[x] “Insight: After Massive Economic Stimulus, BOJ Under Pressure to Do More,” Leika Kihara, Yoshifumi Takemoto and Sumio Ito, Reuters, 2/12/2013. Accessed via Yahoo!
[xi] “Negative Interest Rate Policies,” Carlos Arteta, M. Ayhan Kose, Marc Stocker and Temel Taskin, World Bank, August 2016.
[xii] Source: FactSet, as of 16/3/2023. Statement based on 10-year minus 3-month JGB yields, January 2016 – August 2016.
[xiii] Source: FactSet, as of 16/3/2023. Statement based on Japan bank lending, January 2016 – August 2016.
[xiv] “CNBC Explains: The Bank of Japan’s ‘Yield Curve Control,’” Jeff Cox, CNBC, 21/9/2016.
[xv] “Explainer: How Does Japan’s Yield Curve Control Work?” Leika Kihara, Reuters, 15/1/2023. Accessed via Yahoo!
[xvi] Source: FactSet, as of 16/3/2023. Statement based on 10-year JGB yield, 19/12/2022 – 21/12/2022.
[xvii] Source: Cabinet Office, as of 16/3/2023. The annualised growth rate is the rate at which GDP would grow over a full year if the quarter-over-quarter growth rate repeated in all four quarters.
[xxii] “GDP Stable and Employment up by 0.3% in the Euro Area,” Staff, Eurostat, 8/3/2023.
[xxiii] Source: FactSet, as of 16/3/2023. Statement based on MSCI Japan and World ex. Japan Indexes returns with net dividends, 10/1/1989 – 15/3/2023.
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