Japanese Prime Minister Shinzo Abe won his nation’s elections in late 2012 with bold promises. One of those promises was that the Japanese economy would roar back to life, ending two decades of deflation. He promised a 2% inflation rate in a two-year time span. As that deadline lurches closer, it appears the prime minister’s promise will ring hollow.
Initially, the Bank of Japan (BoJ) did not share Abe’s conviction that it could be done, and it spent most of the year battling government criticism that it was not doing enough to support the economy. After former Governor Masaaki Shirakawa’s term ended in March of 2013, Abe appointed Haruhiko Kuroda to the prestigious job after Kuroda stated Abe’s 2% target was achievable. Now with a hand-picked monetary policy partner, Abe unleashed what came to be known as ‘Abenomics’.
Has Abenomics Failed?
Abenomics is based on three arrows consisting of fiscal stimulus, monetary easing, and structural reforms.
The BoJ was the main driver of the first arrow of Abenomics and was the most proactive central bank in 2013. That year, both the Federal Reserve and the European Central Bank (ECB) backtracked on earlier statements and were subsequently heavily criticized for it. The BoJ “walked the walk and talked the talk” with the announcement it would double the monetary base at the end of year, and the JPY fell accordingly as Japan was on track to import inflation.
Abenomics might have worked if the Japanese economy would not have been hit by four factors: the deterioration of trade with China, energy and food price instability, JPY as a safe haven, and the negative effect on growth from the second arrow and a sales tax hike last April.
Bank officials were so sure they could hit the target that they disregarded their own forecasts pointing to 2016 as a more likely timeframe for when inflation would reach 2%. Earlier this week the central bank’s deputy governor told parliament that its inflation target was not set in stone like a train timetable. Quite a remarkable admission considering the pledge the bank made 18 months earlier.
The Fed: In the Recovery We Trust
It’s unlikely Japan’s central bank will alter its current monetary policy with additional stimulus. Yet the pressure continues to increase for it to get back to providing proactive guidance on the economy. The rhetoric the BoJ used so often has lost its effect, as it has with the ECB and the Fed, and only action will sway the markets. However, the JPY will continue to weaken as long as the Bank of England and the Fed continue on the path to rate hikes by next year. Japan and Europe will still struggle with deflationary battles which will force them to stimulate their economies via bond-buying. This will result in growing interest rate divergence between major economies favoring USD strength.
Stateside, the Federal Open Market Committee (FOMC) meeting concluded last Wednesday. There was little surprise in its post-meeting statement as the Fed announced it will end its quantitative easing (QE) program as planned at the end of October. The interest rate was held at the 0.0% to 0.25% target range. The tone of the statement was a bit more hawkish than expected as there was no mention of European and global growth risks, but the focus was on positive U.S. employment and reduced inflation. The EUR/USD continued to depreciate below the 1.27 price line, fueled by the expectation that a rate hike is forthcoming in 2015, although the exact timing is hard to predict.
The Fed continued to use the “considerable time” language which does not give a hint of when exactly they will consider a rate hike. But even with that line still in the statement, the Fed is the most likely of the major economies’ central banks to hike rates first next year.
Inflation and employment — the two of the main economic gauges the Fed looks at — have an optimistic outlook. Inflation continues to be lower than targeted but a slight pick-up is expected. In general, the members of the Fed’s policy board seemed pleased with the recovery of the U.S. jobs market.
A Dove among the Fed Hawks
There was one dissenter in the FOMC vote. Narayana Kocherlakota voted against the end of QE as he believed inflation would be weaker going forward. Kocherlakota has consistently been a vocal critic of raising rates too early. The president of the Federal Reserve Bank of Minneapolis believes that is the expectation of the market, and he is advising the Fed now to change its benchmark rate until the economy can sustain growth after such a major shift.
Stock markets were expecting the Fed would have been moved by the latest volatility shocks and signs of weakness in the U.S. economy. The resulting hawkish outcome sent stocks downward. Meanwhile, Fed Chair Janet Yellen did not make any comments on the subject during her speech at the Board of Governors of the Federal Reserve System National Summit recently. Her topic focused on the lack of diversity in economics.
U.S. gross domestic product (GDP) beat expectations in the third quarter of the year. The preliminary figures came in at 3.6% growth compared to the forecast of 3.1%. Bad weather last winter drove the first-quarter GDP to a shocking low –2.6% only to come back in the second quarter with a massive 4.6%. The 3.6% marks a healthy pace in U.S. economic growth especially considering the risks posed by Europe and Japan. The GDP figures are in line with the comments from the FOMC statement, further validating the decision to end bond-buying in October.
The EUR/USD pair will continue to be under pressure as better economic and policy member rhetoric support the USD. On the other hand, flash consumer-price index data will be released in Europe, and that could put the ECB under added pressure. More stimuli is needed, the ECB admits, but eurozone states have to agree on a concentrated effort and that’s no easy feat. Germany, namely, does not agree sovereign bond-buying is the best approach for the eurozone, although it would be the most effective.
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