Slow Data From Japan Keeps the Carry Wheel Spinning

This time with slumping retail sales in December as a proxy and obviously the whole show about whether the BOJ should raise continues. Clearly, the hands seem tied on the BOJ since a dropping headline rate as well as declining core prices might very well push Japan into deflation despite its very low nominal short-term interest rate of 0.25%.

(from Bloomberg - linked above)

Japan's retail sales fell in December, signaling consumer spending may be slow to recover from its worst slump in almost a decade.

Revenues at retailers declined a seasonally adjusted 0.2 percent from November, the trade ministry said in Tokyo today. From a year earlier, sales dropped 0.3 percent, the biggest decrease in eight months.

Falling retail sales amid evidence of slowing inflation may make it harder for the Bank of Japan to raise interest rates in February. Governor Toshihiko Fukui and his policy board will look to the Cabinet Office's report on gross domestic product next month for confirmation of a rebound in consumer spending, which accounts for more than half of the economy.

``Today's number is a headwind for a rate hike,'' said Kiichi Murashima, an economist at Nikko Citigroup Ltd. in Tokyo. ``It isn't encouraging for the economy or for the Bank of Japan.''

The yen traded at 121.75 at 12:37 p.m. in Tokyo compared with 121.50 before the report was published.


``Consumers don't have buying power,'' said Shinji Kikuchi, head of research at the association. ``Winter bonuses rose close to 3 percent, but disposable income hasn't increased. Rising pension premiums and taxes have gobbled up the gains.''

The central bank on Jan. 18 voted six-to-three to keep the key overnight lending rate at 0.25 percent, the lowest among major economies. Governor Fukui said the majority agreed it would take more data on prices and consumption to convince them the economy is ready for higher borrowing costs.

Consumer spending fell 0.9 percent in the third quarter of 2006, the biggest drop since 1997, restricting growth in the world's second-largest economy to an annual 0.8 percent.

Over at Morgan Stanley's GEF Takehiro Sato also had an interesting market commentary last Friday on how sluggish price levels and very real probability of a setback into deflation would hinder the BOJ once more, in the first half of 2007, to embark on the much anticipated normalization process.  

Domestic and overseas economies overcame mid-2006 sluggishness and rebounded in Oct-Dec, and risk is mostly to the upside in contrast to lingering bearishness. Yet a dip by Japan’s core CPI rate into negative territory has surfaced as the main scenario rather than a risk. We expect Japan’s core CPI rate to stay at a negative level through F3/08 based on a more conservative view of prices. This reality is likely to restrict BoJ rate-hike action in 2007 to a single move at most in the Feb-Mar timeframe. The rate-hike pace might slightly accelerate in 2008 as prices recover. Below we review revisions to our policy rate outlook based on the outlook for domestic and overseas fundamentals.

Another implication of this continuation of sluggish economic from the domestic economy in Japan is that the Yen stays persistently low against for example the Dollar which in turn helps keeps the carry trade wheel spinning with ever more velocity; perhaps even too fast? In any case Malcolm Knight who is general manager of the BIS used a speech at Davos to note the overcrowded carry trade and excessive leverage in key areas of the market.

(from the FT - linked above)

The level of leverage in the world’s financial system now appears to be rising, partly as a result of growing activity by hedge funds and private equity groups, a senior financial regulator warned on Friday.

Meanwhile, there are now some increasingly “crowded” trades in parts of the the foreign exchange market, including the so-called “carry trade” – which involves borrowing heavily in currencies such as the yen and investing the money in higher yielding assets.

These two factors could potentially create some nasty jolts to the financial system in the future, particularly given the economic wider imbalances which are now building up in the world, warned Malcolm Knight, general manager of the Bank for International Settlements in Basel.

Also Robert Alan Feldman from Morgan Stanley chimes in on this issue in the latest issue of MS' GEF and points the strucutural issues with misalignment and correction pertaining to the underestimated value of the Yen and the subsequent build up of the carry trade. Feldmand invokes the G7 as a forum in which the Yen should be debated and perhaps also from where the Yen could get some support.

The upcoming G7 meetings in Essen on February 9-10 will be an opportunity to air the debate on the misaligned yen. Already, European countries have complained to Japan about the euro/yen exchange rate. For Japan, however, complaints from Europe are not so important.  After all, Japan’s trade with Europe is only about 13% of the total, compared with 63% for the greater dollar block (US, China, SE Asia). Now, complaints from the dollar block are more likely, because of fears of more US protectionism in a Democrat-led Congress. True, the US-Japan geopolitical alliance is stronger than ever. This strength is one reason why the US has ignored the misalignment of the yen so far. However, even the best of geopolitical friends can dispute economic issues.

Investors are not prepared for G7 action on exchange rate misalignments. Indeed, Tokyo clients this week have been as stunned and intrigued by the mention of possible dollar-selling by MoF as were global clients at MacroVision last week. Careful attention to the vibes coming from the G7 is warranted. Indeed, should investor perceptions change, then a sharp stock adjustment in the foreign exchange market would become more likely, in my view.

I am not sure I agree with Mr. Feldman here. In any case we have seen this before as the G8 also tried to perk up the Yen back in September but back then talk indeed was cheap and I fear it will be so again. In fact, this surprises me in the case of Feldman since he himself, only a few days ago, suggested that investor corrected to the fundamentals of the Japanese economy instead of the rhetorics of the BOJ and the Japanese policy makers. Surely this goes for G7 rhetorics as well or what?

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