Richard Koo: “Honeymoon For Abenomics Is Over”
As we noted just two weeks ago – before the hope-and-change-driven exuberance in Japanese equities came crashing down – “those who believe in Abenomics are suffering from amnesia,” and Nomura’s Richard Koo clarifies just who is responsible for the exuberance and why things are about to shift dramatically. Reasons cited for the equity selloff include Fed Chairman Ben Bernanke’s remarks about ending QE and a weaker than expected (preliminary) Chinese PMI reading, but, simply put, Koo notes, more fundamental factor was also involved: stocks had risen far above the level justified by improvements in the real economy. It was overseas investors (particularly US hedge funds) that responded to Abe’s comments late last year by closing out their positions in the euro (having been unable to profit from the Euro’s collapse) and redeploying those funds in Japan, where they drove the yen lower and pushed stocks higher. Koo suspects that only a handful of the overseas investors who led this shift from the euro into the yen understood there was no reason why quantitative easing should work when private demand for funds was negligible…
Had they understood this, they would not have behaved in the way they did.
Many domestic institutional investors understood that private-sector borrowing in Japan is negligible in spite of zero interest rates and that there was no reason why monetary accommodation—including the BOJ’s quantitative easing policies – should be effective. In that sense, the period from late last year until mid-April was a honeymoon for Abenomics in which everything that could go right, did. However, the honeymoon was based on the assumption that the bond market would remain firm. The recent upheaval in the JGB market signals an end to the virtuous cycle that pushed stock prices steadily higher.
Via Nomura’s Richard Koo,
Divergence in investor behavior fueled virtuous cycle of lower yen and higher stocks
More specifically, the sharp rise in equities that lasted from late in 2012 until a few weeks ago and the several virtuous cycles that fueled this trend were themselves made possible by a special set of circumstances.
Whereas overseas investors responded to Abenomics by selling the yen and buying Japanese stocks, Japanese institutional investors initially refused to join in, choosing instead to stay in the bond market.
Because of that decision, long-term interest rates did not rise. That reassured investors inside and outside Japan who were selling the yen and buying Japanese equities, giving added impetus to the trend.
Japanese institutional investors understand private demand for funds is negligible