In his latest piece, Nomura economist Richard Koo examines the recent crash inwards the Japanese stock market, which has tumbled 15% since but May 22.
"The prevailing take in is that nosotros are finally seeing a reaction to this excessively rapid move, in addition to if so this is a salubrious correction," he begins. "The reality, however, may live on somewhat to a greater extent than complicated."
Koo argues that the primary driver of the big upward movement inwards the Japanese Nikkei 225 so far has been hedge funds exterior of Nihon who were previously betting against the euro.
Then, in conclusion September, when the ECB introduced a novel monetary stimulus programme that undermined the fearfulness inwards the marketplace that the euro could collapse, those international hedge funds had to respect something else to bet against.
Koo writes (emphasis added):
Late in conclusion year, the Abe regime announced that aggressive monetary accommodation would live on i of the pillars of its three-pronged economical policy. Overseas investors responded yesteryear closing out their positions inwards the euro in addition to redeploying those funds inwards Japan, where they drove the yen lower in addition to pushed stocks higher.
I suspect that exclusively a handful of the overseas investors who led this shift from the euro into the yen understood at that spot was no ground why quantitative easing should operate when individual need for funds was negligible. Had they understood this, they would non convey behaved inwards the way they did.
Japanese investors, Koo asserts, did empathise this. That's why they didn't bring together inwards when international hedge funds started buying upwardly Japanese stocks inwards size (emphasis added):
Whereas overseas investors responded to Abenomics yesteryear selling the yen in addition to buying Japanese stocks, Japanese institutional investors initially refused to bring together in, choosing instead to remain inwards the bond market.
Because of that decision, long-term involvement rates did non rise. That reassured investors within in addition to exterior Nihon who were selling the yen in addition to buying Japanese equities, giving added impetus to the trend.
However, Japanese investors' initial aversion to the long Nikkei merchandise couldn't in conclusion forever.
"Even though the moves inwards the equity in addition to forex markets were led yesteryear overseas investors amongst lilliputian noesis of Japan," says Koo, "the resulting improvement inwards thought in addition to the extensive media coverage of inflation prospects forced domestic institutional investors to get selling their bonds equally a hedge."
That selling caused yields in addition to volatility to rising inwards the Japanese regime bond market, which spooked investors in addition to arguably sparked the big unwind inwards the Nikkei trade.
But why should rising bond yields live on such a bad affair for the "Abenomics" flush of experimental economical stimulus inwards Nihon that international investors convey placed their faith inwards yesteryear running upwardly Japanese stocks? After all, higher yields reverberate rising inflation, which is i of the principal goals of Abenomics.
The problem, according to Koo, is that a rising inwards inflation earlier the Japanese economic scheme starts to recover is bad news:
The Bank of Nihon began buying longer-term JGBs on four Apr amongst the destination of pushing yields downwards across the curve. The lawsuit of those purchases, however, has been just the contrary of what Governor Haruhiko Kuroda intended, amongst long-term bond yields moving higher inwards response.
Domestic mortgage rates convey increased for 2 consecutive months equally a result. This is clearly an unfavorable rising inwards rates driven yesteryear concerns of inflation, equally opposed to a favorable rising prompted yesteryear a recovery inwards the existent economic scheme in addition to progress inwards achieving amount employment.
The to a greater extent than the marketplace senses the BOJ’s determination to generate inflation at whatever cost, the to a greater extent than involvement rates—and especially longer-term rates—will rise, adversely impacting non exclusively Japan’s economic scheme but also the fiscal positions of banks in addition to the government...
Since at that spot is no increment inwards banking concern earnings from additional lending activity in addition to no increment inwards taxation revenues from a recovering economy, the financial positions of banks in addition to the regime deteriorate inwards right away proportion to the rising inwards long-term involvement rates.
In other words, rising rates aren't bad if they reverberate a strengthening economy, because the losses banks volition sustain inwards their bond portfolios volition live on offset yesteryear increased revenues owing to a stronger economic scheme inwards general.
Again, though, Koo does non squall upwardly that is the scenario unfolding inwards Nihon right now:
Only 22% of people surveyed yesteryear the Nikkei felt Japan’s economic scheme is genuinely recovering (27 May 2013), suggesting relatively few convey benefited from Abenomics’ honeymoon thence far.
Moreover, an increment inwards long-term rates at a fourth dimension when 78% of the population is non personally experiencing a recovery is nearly probable a “bad” rising inwards rates, in addition to the authorities bespeak to address it rattling carefully, keeping a closed oculus on individual need for funds.
All of this way that the big upward thrust inwards Japanese equities that began belatedly in conclusion twelvemonth has probable come upwardly to an end, at to the lowest degree for now.
"The recent upheaval inwards the JGB marketplace signals an halt to the virtuous bicycle that pushed stock prices steadily higher," says Koo. "This way farther gains inwards equities volition require stronger corporate earnings in addition to a recovery inwards the economy."