“Japan matters,” says Société Générale strategist Albert Edwards in his latest note to clients.
Developments in Japanese economic policy are so important, according to Edwards, in fact, that they “could accelerate the trend towards lower U.S. bond yields, whether or not the Fed tapers.”
The Federal Reserve is considering winding down its third round of quantitative easing. When it finished the previous two rounds, Treasury yields fell.
“My own view is that the end of QE3 will bring exactly the same market response as the end of QE1 & 2,” says Edwards.
At the same time, the SocGen strategist expects a combination of a controversial consumption tax hike scheduled for April in Japan and an overheating labour market there to finally stoke inflation — a lot more than Japanese policymakers are currently trying their best to bring about.
That, he says, sets up a repeat of 1996-1997, “where yen weakness put a severe strain on other Asian countries balance of payments and contributed in large part to the 1997 Asian currency crisis.”
“I expect yen weakness over the next year to begin accelerating out of control as BoJ QE is stepped up, forcing widespread devaluations in the [emerging markets] world, including China,” writes Edwards. “The impact of this on the West is not rocket science. There have only been two occasions when US implied inflation expectations have turned negative — 2008 in The Great Recession and 1998 in the wake of the Asian crisis.”
Edwards points to recent economic data releases that suggest labour shortages are sparking wage growth:
The recently published Japanese Tankan survey of companies showed a sharp acceleration of the trend towards labour shortages. Although this may be surprising given Japan’s anaemic economy over the last decade, it is another consequence of the rapidly ageing population. The product market is still loose but the labour market is not.
The consequence of this is pretty straightforward. We should expect to see a tight labour market resulting in an acceleration of wages. The first signs of this have just started to appear in recent data. Indeed higher nominal wage inflation has been cited by PM Abe as an essential component to exiting deflation.
“So I am thinking that the hike in the consumption tax in Japan may play a role in shifting inflation expectations higher when juxtaposed with the BoJ moving to QE2, a sliding yen, rising wage inflation and rising property prices,” says Edwards. “And if we get a lift-off in Japanese inflation via a wage/price spiral, the future for the world’s financial markets will look very different from what we have become used to over the last 20 years.”