FX Daily: Abenomics Final Arrow Fails to Hit the Target

25th June 2014 By: Eimear Daly

  • US may be initiating steps to ease a decades-long ban on the export of crude by allowing 2 energy companies to ship a kind of ultra-light oil that has become plentiful due to the shale oil boom. (WSJ)
  • BREE forecasts iron ore spot prices to average $105/tonne in 2014, 16% lower than 2013. At current prices a large proportion of China’s domestic production is still assessed as loss-making. If a number of these close before end 2014, it would provide some price support for the sector. (BREE)
  • Commercial property investors in Asia are seeking property investments outside of Asia for the first time as real-estate yields have fallen to the lowest in the world. (WSJ)
  • BoE’s Haldane has told borrowers that coming UK interest rate rises will be gradual and not reach the peak levels seen in the past, levelling out at a “new normal” area of between 2% and 3%. (Yorkshire Post)
  • A PBoC source says the bank’s new targeted reserve cuts won’t be very frequent, with the last based on 2013 lending to agricultural and small business, and the next to be in 2015, based on this year’s lending situation. (China Securities Journal)
  • Expanding reserve requirement cuts risks more money flowing into real estate and other asset bubbles rather than to small businesses and other areas of the real economy which need them. (People’s Daily)
  • China’s NAFMII, one of the interbank bond regulators, is studying measures to allow qualified property developers to raise debt in the markets as a way to ease the pressure they face. (21st Century Business Herald)
  • So far this year, at least 16 cities have eased house purchase controls, loosened conditions for residence permits to buy houses or adjust housing provident funds. (Chinanews.com)
  • Japan’s PPI Services rose 3.6% annual, versus a prior reading of 3.4% and 3.3% expected. Excluding the impact of sales tax hike, the indicator is calculated at 0.9% annual.
  • Spain May PPI came in at -0.4% annual, versus -0.2% previously.

Bank of England Governor Carney came in for some serious flack following his testimony to the Treasury Select Committee yesterday. Carney’s apparent discomfort with low wage growth was construed by markets to be our inconsistent and changeable BoE Governor taking another policy u-turn. One prominent policymaker even referred to him as an unreliable boyfriend. The members of the MPC struggled to explain the contradiction in strong nominal growth rates and vibrant employment gains against weak wage growth and benign inflation. Carney reasoned that the discrepancy in the data suggested something isn’t right about this recovery and concluded that “there is additional spare capacity in the UK labour market that can be absorbed before rates rise”. Deputy Governor Bean and member David Miles were even more dovish. Miles believed there was more spare capacity in the UK than the BoE’s consensus 1-1.5% estimate while Bean even suggest that later rate rises that risk inflation are preferable to earlier rate rises that forego potential output growth.

The Monetary Policy Committee is a democracy not a dictatorship. This was in fact what politicians campaigned for and the reason we brought in a new BoE Governor from so far afield to shake up the previous governorship what was consistently accused of “group-think”. The contradictions in this recovery mean that the monetary policy outlook is crucially dependent on how individual members interpret the data. The BoE meeting minutes consistently refer to a “considerable uncertainty” around spare capacity estimates and a “range of views” around the outlook for growth. The disparity in the data is likely to divide the Committee right down the middle between the hawks whose natural intuition tells them that 3% annual growth rates and rapid falls in unemployment mean it is time to hike and those that cannot shake the unnerving feeling that wages and productivity should have picked up by now. The three members that spoke at the Treasury Select Committee fall into the latter category Carney finds himself in a particularly awkward position as he has to speak for the whole of the MPC as well as give his own opinion. The Treasury Select Committee hearing was Carney’s personal take on the recovery while the hawkish Mansion House speech and June BoE minutes was him speaking on behalf of the Committee. We do not have a problem with policy inconsistency in the UK instead we need to adjust to a Bank that isn’t just singing from one hymn sheet. The UK got what it wanted Fed- style monetary policy where outspoken individual views can diverge from consensus and allow for a health debate on policy. What we have to remember, however, is that it is consensus that decides policy. Carney, Miles and Bean exposed themselves as doves yesterday but the consensus view hasn’t changed. The probability for a rate rise this year is significant.

We continue to forecast the first rate hike in November 2014 as the hawks outnumber the doves. Sterling fell all the way from $1.7030 before the announcement to under the $1.70 level and was pressed all the way down to $1.6953 in this morning’s trade. The market is still heavily long the pound and dovish comments will cause the weaker long positions to be unwound. However yesterday’s Treasury Select Committee changed nothing – the UK growth is rapidly accelerating and thus the BoE looks to be the next G10 bank to hike. We see sterling-dollar reversing its losses and trading back above $1.70 in the near term with $1.73 a 6 month target.

Japan’s PM Abe unveiled his third arrow of structural reforms yesterday. It’s been 18 months since Abenomics was first introduced and these essential reforms have been much talked about but seen little implementation. With a rapidly aging workforce and towering public debt, Japan faces the mammoth task of needing to increase productivity, labour participation and implement fiscal consolidation, an objective the IMF recently described as “really quite difficult if not impossible”. Abe announced over 200 reforms yesterday, the most significant are legalising casinos, lowering the corporate tax rate, changes in labour force regulation including greater female participation and loosening immigration laws, and changes to make the government pension fund a more active equity investor. The last measure probably has the most bite. The measures do represent a significant cultural first step for Japan, but it is not sufficient to overhaul a decade of anti-business practices that are now embedded in Japan’s culture. Measures to allow foreign healthcare workers in strategic zones needs to broadened to the entire country and a 5 year maximum visa for foreign construction workers needs to be extended and red tape removed. A tax that disincentives spouses from working has to be abolished and we question if the tax revenue shortfall needed to fund a lower corporate tax will fall yet again on consumers. We still believe the BoJ will be forced to increase QQE into year end as the decline in the import price index from January suggests the past depreciation of the yen won’t be able to support price growth much longer. This should support a move higher in USDJPY as well as the widening interest rate differential and Japan’s weaker current account position.