Macro Report:End of the line for AbenomicsWhy Japan is increasingly vulnerable to a financial crisis

Overview:

    Abenomics was cheered by markets globally as Japanese Prime Minister Shinzo Abedeclared that “Japan is back” as he took office at the end of 2012. However, three and a halfyears later, Japan’s economic momentum has faded, and with it, much of the optimism forJapan’s promised revival, with Abe stating at the G7 conference that the global economicoutlook is worse than in 2008. With the economy and markets weak, Japan once againneeds more stimulus, but this time, policymakers are running out of tools to work with.

    The monetary policy arrow of Abenomics was seen as a resounding success during the firstyears of Abenomics. The impact of easing was seen on the exchange rate and asset pricesin particular, as well as a relatively short-lived lift to inflation, though it failed to boost wages.With the recent foray into negative interest rates, the BoJ showed some desperation as itapproached the limits for policy easing.

    Fiscal policy has had two seemingly mutually exclusive goals of providing stimulus whileaiming for fiscal consolidation, and thus far Japan has not been particularly successful ineither, as supplementary budgets and a corporate tax cut have not restored growthdynamism, while the April 2014 consumption tax hike halted the recovery momentum, andsubsequent tax hikes have already been delayed once with a second delay likely in our view.

    Lacking a viable alternative, it is likely that Japan will continue to limp on with the Abenomicspolicies, further widening the already significant distortions in the economy and financialsystem. Due to the enormous QE program, the BoJ holds approximately 1/3rd of outstandinggovernment bonds, and over half of the ETF market, and is a top 10 shareholder in over 200of the 225 companies in the Nikkei 225 index. Asset prices have been increasingly proppedup by central bank action, and debt levels remain unsustainable as the governmentcontinues to miss targets for fiscal consolidation.

    Though Japan has been and continues to function as a safe haven in the short run, in ourview it is far from safe. With major financial market distortion exacerbated by the Abenomicspolicies, an ever-growing mountain of debt, demographic factors that continue to take a turnfor the worse, and little foreseeable solutions ahead, Japan is more likely to be at the centerof the next financial crisis rather than a suitable place to hide from it.