The bout of uncertainty that has encircled the globe has already caused casualties in financial markets as risk aversion and heightened volatility send investors scrambling for haven assets. One of the first areas this phenomenon was evident was in the USDJPY pair which responded forcefully, briefly falling below the 100.00 psychological threshold as the carry-trade was rapidly unwound. However, the carry-trade was not the only factor behind USDJPY hurtling lower. Abenomics has largely been unable to raise the bar when it comes to reaching the ambitious inflation targets set by the Central Bank. Now that Abe has cemented his support in the government with the Liberal Democratic Party securing the upper house of the Japanese Diet (parliament), pushing through additional stimulus measures should be a breeze, helping to offset some of the recent strength in the Yen and send USDJPY higher over the coming weeks.
LDP Tightens Its Grip
The sweeping election victory in Japan has led to a global risk rally that has included Asian, European, and American equities, sending the S&P 500 into record territory with a new high close. However, long before the victory, all was not well with the Japanese economy. Slipping fundamentals have raised the stakes for Shinzo Abe, especially after the high profile failure of his first three arrows.Inflation has been a troublesome indicator for the Central Bank, with annualized consumer prices printing in negative territory during 3 of the last 4 readings, with the latest showing deflation of -0.40% and only deepening as time passes.Although Japanese firms have reported record profitability over the past several years due to the weakening of the Yen, those gains have not translated to upside in wages, a factor that is keeping the downward pressure on inflation persistent.
One of the main problems going forward for the Bank of Japan is its already sizable balance sheet which is only growing over time, hurting the markets pricing function in bonds especially as the Central Bank soaks up available liquidity. The amount of purchases also makes it difficult for the BoJ to expand the existing program further, meaning that the next stimulus move will have to take a different approach. With former Federal Reserve Chair Ben Bernanke meeting with Shinzo Abe earlier, the takeaways from the meeting include a focus on fiscal stimulus, or heightened government spending in order to combat deflation and negative price growth.Fiscal spending will also likely help alleviate pressure in other areas especially after the latest machinery orders data which showed a year over year contraction of -11.70%.
