In recent weeks the Japanese Yen has come back down to earth, while contributing to a bull market for domestic stocks. The Nikkei 225 stock index surpassed 11,400 today, registering another 2.1% gain to add to its 26% run up over the past three months. Over the same period the yen has sunk by nearly 30% to its current 93.98 to one U.S. dollar level, a 33-month low. For a market that has been in free fall or otherwise stagnant for decades, what has recently prompted the reversal of fortune?
Newly elected Japanese Prime Minister Shinzo Abe has taken a dovish stance on the currency, changing the long held stance by his predecessors. He is threatening the Bank of Japan that if it did not hit its 2 percent inflation target, which it set in January, it would become necessary to change the laws under which the Bank of Japan operates. In other words, Japan is printing more yen to circulate in the market thereby raising inflation and hopefully incenting foreign markets to buys its domestically produced goods. Mr. Abe has pledged that one day his government will work to reduce a budget gap that is now more than 50% of annual government spending. But in the meantime his administration has launched a ¥10 trillion ($106 billion) spending package designed to pull the world’s third-largest economy out of its downturn and help to end deflationary pressures. All of this to say that Japanese stocks are on a run not see since the boom years of the late 1980s but how long can it last?
Holding back the Nikkei has been Japan’s colossal debt load, now estimated at well over 200% of annual GDP in gross terms, as well as prolonged deflation and an aging population. For now the credit rating agencies are holding firm despite the dovish moves by the policymakers. Japan’s bond market has largely ignored the increasingly dire warnings from the IMF and the Bank of Japan. S&P reaffirmed its AA-minus rating on Japan’s sovereign debt recently, saying it needs more time to draw conclusions on the impact of “Abenomics” under the new government of Prime Minister Shinzo Abe. Have we started the race to the bottom as developed-market economies inflate their currencies to incent domestic growth? Let’s hope Japan can finally see some reasonable economic activity to offset their rising debt burden.
