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As expected, former Japanese Prime Minister Shinzo Abe won big in this weekend’s election. And he ran on the campaign of pushing aggressive monetary policy in an effort to stimulate the economy.The implication is that the Japanese yen would fall and inflation would rise.
But Goldman’s Jim O’Neill thinks that the leadership change is a bit overhyped. He wrote about it in his Viewpoints note just ahead of the election:
A number of people – who, I think, understand the Yen quite well – don’t believe this is a big story in the making, suggesting two reasons why: Firstly, despite all the headline- grabbing comments of Abe, the inherent conservatism of Japan will allow the BoJ to continue to treat inflation targeting as a “goal” as opposed to a “target”. Secondly, linked to this, other governments won’t “allow” Japan to weaken the Yen much, given their own policy bias and desires. Listening to these comments, both slightly concerned me but also meant that there are lots and lots of people that can change their view pending what an Abe-led LDP can deliver, assuming it is in a position to do so.
Regarding the two points of contention, I discussed the second one with a Japanese official this week, and I simply think it is quite straightforward. There is a big difference between a Yen that weakens because of intervention and one that weakens because of fundamentals and market forces. For the US in particular, that has repeatedly said its formal policy on foreign exchange is for markets to be allowed to set the rates, and for a country whose central bank quite likes using QE to help its domestic economy, it is not credible that they could complain about Yen weakness if it were an outcome of domestic Japanese policy. On the first, I have some sympathy given Japan’s past, but surely the whole point of Abe and his closest allies is that they want to re-assert their belief in domestic Japanese pride (and in this regard, this is partly why the island dispute with China came around and under a strong LDP led government could resurrect).
Some forecasts on the yen from O’Neill:
…assuming he wins and moves ahead with his plans, I think we are going to Y88, possibly very soon. Moreover, if the US positively surprises as I discussed earlier, then this could be a story for a move to Y100-120 in the next 12-24 months.
O’Neill also talks about the idea that a weak yen would be bullish for the Japanese stock market. This is also known as the new Gundlach trade.
As for the Japanese markets and the Yen linkage, by now, there is quite widespread market belief that if the Yen weakens, one wants to own the Nikkei and obviously with an export orientation. But as my colleague James Wrisdale points out to me, if the Yen weakens because of new domestic fundamentals, and investors believe that this has a higher probability of working, then presumably there will be even bigger domestic Japanese equity plays to focus on, especially the ones that might benefit from an end of fears of constant deflation. Along with this, perhaps there could be lots of changes with respect to domestic asset allocation.