Japan’s Efforts to Avoid Recession, Comparison With Central Bank Activity and Focused Easing

Bank of Japan’s Expansion of Easing and Bank Funding, With other Central Banks

Japan’s economic indicators are showing weakness and expectation is Japan entering recession in Q4. Where European Union has slipped into technical recession, Japan seems next. Company revenues generally disappointed in Q3, though analysts moderated their projections through the quarter. In Q3, analysts also moderated their earnings projections. With revenue disappointing, considerable declines in earnings could be realized.

Real question is what catalysts exist to prevent recession in Japan and sustain demand, and therefore sales.

Countering Japan’s economic numbers are efforts of Bank of Japan. In September, Bank of Japan (BOJ) announced a 10T (Trillion) yen increase in its already existing asset purchase program, raising total easing purchases to a projected 80T yen.

This announcement was relatively concurrent with U.S. Fed’s September QE3 announcement consisting of $40B/month in mortgage backed security (MBS) purchases. European Central Bank also announced their Outright Monetary Transactions (OMT), which cooled Spanish and Italian yields.

Bank of Japan took further steps in October by raising their easing programs another 11T yen, to a total 91T yen. Where U.S. QE3 remains stable and ECB’s OMT remains untapped so far, BOJ is expanding their asset purchases.

Not only does BOJ have an expanding asset purchase program, but also exceptional funding for banks, similar to United Kingdom. BOJ has ear marked 66T yen for asset purchases and 25T yen for bank funding to promote lending.

BOJ’s Asset Purchasing Projections, Japan Market Responses and Other Central Banks

For BOJ’s asset purchasing, it is a diverse program which involves risky assets. According to BOJ’s description of its asset program, the bank has 39T yen earmarked for Japanese government bonds, not unusual. They have 19.5T yen reserved for Treasury Discount Bills, again not unusual.

What is of note, and according to BOJ information, bank is putting 3.2T into commercial paper. 2.1T into exchange traded funds (ETF’s) and .13T into equity issued by real estate investment corporations. Appears BOJ is taking equity stakes.

Interesting for BOJ’s approach is when they announced their enhanced easing in October, Japan’s major stock index, Nikkei 225, fell 1%. Of course concurrent worries of territorial disputes with China existed as with European issues. Still, long term prospects for BOJ’s balance sheet perhaps raised concern.

Contrasting is U.S. QE, which so far remains constricted to MBS’s. Also is ECB’s OMT’s, which remains confined to sovereign bonds of a country requesting assistance. It appears Spain has not made a request most likely out of protection of its sovereignty. Recent Catalonia elections, however, could force matters.

BOJ’s Measures to Promote Bank Lending, Covering Natural Disaster

BOJ also has two bank funding plans. Firstly is its “Growth Supporting Funding Facility” of 5.5T yen, increased in March by 2T yen and currently tapped at 3.4T yen. Then is BOJ’s loan promotion called “Stimulate Bank Lending Facility”, of some 19.5T yen.

Growth Supporting Funding Facility looks to be a rebuilding effort in Japan’s tsunami and earthquake devastates areas. Starting at 2.1T yen, BOJ announced in March an increase of 3.4T yen to a total of 5.5 T yen. BOJ Governor Shirakawa also announced relaxing program restrictions in order to reach smaller lenders and promotion of access to loans for medical providers. Loans under this program look to be .1% and require application review.

When this announcement was made in March, Japan stocks fell and yen rose against U.S. dollar. Apparent was market disappointment in BOJ not announcing other easing measures. But added easing certainly came in September and October.

Promoting Bank Lending on an Organic Basis, Like BOE’s Similar Efforts: Results Awaiting

Next bank funding mechanism for Japan is its “Stimulate Bank Lending Facility” announced in October. This facility appears to have 19.5T yen of ammunition (though “unlimited”) and is a funding facility tied to net bank loans. Much like BOE’s “Funding For Lending Plan”.

BOJ’s Stimulate Bank Lending Facility grows out of what Governor Shirakawa expressed in his November 12 speech in Tokyo. He said “The bank hears from many corporate managers that there are only a few attractive investment opportunities at home.”  Explaining cause for a proposed solution, Shirakawa offered, “Unless we somehow manage to change this view, it will be difficult to stimulate business investment.”

Program details appear rare. Still based on BOJ documents, it is tied to net Japanese bank lending, can be yen or foreign currency denominated.

Analogous is BOE’s Funding for Lending Plan, which started in August and is a collateral swap program. British commercial banks swap their previously authorized collateral for United Kingdom treasuries. Values of U.K. treasuries a bank may swap are tied to amount of new lending the bank undertakes prior to program expiration. Enforcing the program is a penalty fee imposed on a bank should their net lending fall below a baseline.

 

For England, and yet to be known by Japan, is British Banker’s Association reporting progressing increases in mortgage lending, and in the period of October over September. BOE is, however, saying that it is too early in program progress to know actual effects.

 

Currently, it looks that new easing measures among countries are becoming much more directed and focused on particularly weak areas. This contrasts with previous easing that generally tended to flood markets with cash. More precise measures looks to focus liquidity in a manner that increases direct investment demand and employment.  

European Union In Recession, Japan Recession Looks Next

Company Revenue Declines Reflect Progressing Global Slowing

Preliminary U.S. GDP numbers will be announced Thursday with current consensus range being 2.8% to 2.9%. Such numbers seem ambitious given earnings season results. Where over 70% of companies reported earnings above expectations, a startling 60% disappointed on revenues. This marks the lowest beat rate on revenues since Q1, 2009, according to Factset.

Earnings can be made to look good by shifting accruals and creating efficiencies. Revenues are sales and they either exist or they don’t. Through revenues, one gains insight into fundamental demand.

Europe is an obvious explanation for apparent demand weakness. Europe also appears to be trending into added weakness.

Europe is now in recession with two straight quarters of GDP contraction. Most recent Q3 data shows a EU -.1% GDP contraction. This combines with a Q2 contraction of -.2%. Most concerning is Germany, EU’s chief financier. On November 23, Germany reported quarter over quarter GDP decline from Q2 growth of .3% to Q3 growth of .2%. Year over year, Germany’s GDP growth went from 1% in Q2 to .9% for Q3. More concurrent industrial production numbers show German production contracting -2.1% in October.

Japan Q3 GDP Contracts Sharply, Against Its High Sovereign Debt

Projections are next for Japan to fall into recession. Q3 results show Japan’s GDP declined a marked -3.5% versus Q3 2011, its largest contraction since March 2011’s tsunami strike.

Of Japan’s GDP, a cut of .7% came from faltering exports. A concerning feature given Japan’s declining Terms of Trade recently discussed on this space and its implications for Japan to sustain its debt, which ranges 220% of GDP. Highest among G7 countries.

Private capital investment, on the GDP report, saw caution assert with a decline of -3.2% versus Q2.

Japan’s Exports Continue Into Weakness, Now Imports Look To Further Weaken

Troubling for Japanese exports is an ongoing dispute with China over what Japan calls the Senkaku islands (China calls them Diaoyu islands). Consensus is this dispute now creates an outsized impact on trade between China and Japan. China is Japan’s largest trading partner accounting for 20% of Japan’s exports in 2011 compared with U.S. buying 15.3% according to Japan External Trade Organization numbers.

On November 20, Japan reported its merchandise trade results for October. This data reveals balances between exports and imports. According to data, Japan showed a steeper than expected trade deficit of -549B yen, expectation was for a -337B yen deficit. More troubling for global demand is Japan’s exports contracted by -6.5% in October, and its imports also contracted some -1.6%.

Exports for Japan are now down for a 5^th consecutive month, but exports to U.S. have been positive for 12 month and up 3.1% for October. Perhaps demonstrating U.S. decoupling from general global weakness (despite a strong yen). Still, creating real concern for U.S. is Japan’s negative import number of -1.6%, first time in only two months, indicating volatility looking to trend into weakness.

Deflation Marks Japan’s PPI, Japan And China Show Major Weakness In Steel Prices

Released November 11 was Japan’s CGPI (corporate goods price index) which is akin to a producer price index (PPI) and monitors price inflation, or deflation. October price results show deflation in Japan with producer prices falling -.3% month over month and -1.0% year over year. This index is trending into deflation with October bringing a 7^th consecutive monthly decline.

For particular businesses, weakening is most noted in electronics at -3.6% and lumber -3.4%. But what really shows weakness is iron and steel prices down a concerning -9.9%.

Declining steel pricing in Japan combines with a similar result from China’s PPI (released November 8). China’s PPI showed ferrous metals down 11.4% for October, after contracting 12% in September.  

Looking at other economic indicators for Japan, none  point to positive results. General propositions suggest Japan entering recession. However, Bank of Japan has been hard at work with a variety of programs, which includes a very diverse asset purchase program that’s been growing.

Recent Fiscal Talk Meets Declining Company Revenues: Cost of Capital

Widening Credit Spreads Are Supported By Declines In Company Financials

Of notice are current credit spread increases associated with serious winds out of Europe and other matters. Currently, credit spreads are increasing in recognizable terms. Such increases can be noise, or a real deal on market moves. Due to last quarter's moves in fundamental financial performance of companies, namely disappointing sales results, widening spreads aren't surprising. Credit spreads, company sales and sovereign debt all appear correlated.

Credit spreads have been in a condition of widening since October. But over the last few trading sessions, spreads have been moderating. Encouraging in this regard are optimistic market responses brought by politicians addressing U.S. fiscal issues. Because fiscal approaches right now are nascent and undefined, strong market responses seem a little irrational.

Fiscal Talk Starts An Economic Anchor, But For Fundamental Conditions To Improve, The Anchor Must be real  

Where central banks have held the dike, giant leaks are showing not necessarily in company earnings, but in sales, and cash flow. Inevitably declines in revenue and cash flow can appear in considerable earnings disappointment. We are seeing this progressing weakness in most recent reports on earnings.

Company revenue and cash flow issues certainly threaten investor expectations of increased dividends and share buy backs, let alone capacity for fundamental or organic growth. Despite very low interest rates, when declines in revenue are experienced, cost of capital for companies increase especially on the equity side.

Increased cost of capital diverts management's attention to transitioning into cheaper capital, being debt currently given low growth prospects longer term. Cost of debt needs to stay stable. Stability in this area should enhance return rates, confidence and make equity pay. Equity pays only with higher rates of organic business growth. 

Equity comes with increased risk over prioritized debt.

Company Revenues Take Time, Political News Cycles Occur Overnight

What took time to develop was company weakness in revenues and cash flow. What hasn't taken time is  lots of optimistic buying due to fiscal lip service. Company financial statement fundamentals remain necessary for business function, let alone equity growth.

U.S. has an interest rate on its debt not deserved by its fiscal situation. A Q4 question is whether equity prices are reaching a similarly undeserved level, given increased prices of equity due to declining fundamental growth.

Worry exists that news cycle flashes will only create an illusory solution. Should markets respond on illusory lip service....too much encouragement grants a license for continued talk.

U.S. Has a Debt Issue, Compounding is Japan's Debt Issue

Debt Presses Europe, Now U.S., Next Japan

Obvious new dynamics are occurring in highly developed countries. Debt issues are progressing beyond capacity for easy resolution and grow to become a mirror that fiscal policy leaders do not want to see. Also obvious is progression of this dynamic moving from Europe into U.S. Next will be Japan.

Japan is unique in that most of their debt is domestically financed, as opposed to foreign investment. But, for Japan, a shrinking global economy bodes that their ability to domestically finance debt will also shrink congruent with slowed global growth.

On November 8, Japan's finance ministry reported a current account deficit for September. First time in 30 years. Japan's terms of trade (a ratio of export prices against import prices) has been in deterioration as value from exports wane against costs of imports. From 1960 through 2012, terms of trade for Japan have averaged 174.56. In August, 2012, Bank of Japan said the number stood at 90.50.

Based on more concurrent indicators, terms of trade numbers aren't improving for Japan.

Where Europe has managed to kick a can down a blind road, chances for other countries, namely the U.S. and longer term Japan, to perform in like manner diminish. Perhaps significantly. All due to progressing global weakness.

Hope of economic growth increasing government revenue to offset debt not only is looking bleak, but government debt is too large for realistic growth rates creating a meaningful offset on debt.  Austerity can't be avoided. Still, austerity's reach needs to be balanced, to avoid strangling growth. Historical analogies don’t really exist, certainly in an integrated global economy.

What is known, U.S. Congress needs to look more adult and less childish. Winning political party battles on scorched earth efforts, leaves a scorched America.