Elections Do Matter, Especially Japan’s
In the wake of Tuesday night’s U.S. elections, I have been asked what the potential impacts will be on the capital markets. In the November “Vital Signs,” we correctly anticipated that Republicans would gain control of the Senate, add to their majority in the House, and slightly increase their edge in governorships. From here, determining how the incoming “kindergarten class” will operate the academic institution that is Washington D.C. comes down to a coin flip. At the simplest level, I would imagine the symbolic change in leadership could be positive, and possibly address the need to accelerate domestic growth, in particular for the middle class. However, kindergarten can be chaotic and complex, anything but simple.
Now let’s consider an election that has, and will, continue to have a strong influence on global capital markets. It occurred in December 2012 and placed Shinzo Abe in the position of Japanese prime minister. Mr. Abe brought along with him an aggressive fiscal and monetary easing plan, known as “Abenomics,” to fight decades of deflation. Thus far, Abe’s policies have been very beneficial to global capital markets and risk assets.
Of all the global governing policies to impact markets, Abenomics has been the least volatile and consistently positive since late 2012. Fueled with a high degree of confidence that Abenomics will gradually weaken the Japanese yen over time, speculators have utilized the yen as the funding currency for a global carry trade. Sell the yen and utilize the funds to purchase risk assets has been a consistent and profitable theme since late 2012.
As the Bank of Japan (BOJ) continues to put forth easy monetary policy, the yen has weakened, pushing the U.S. dollar/Japanese yen cross 50% higher, from 76 (yen per dollar) in 2012 to 115.52 earlier this morning (Figure 1). Investors should not allow human nature to prevail over pure fundamentals and conclude that the move is potentially over just because of the extreme price change. The BOJ and Prime Minister Abe will continue to push ahead policies, surprising markets when needed, to achieve a 2% price stability target. The U.S. dollar/yen cross has both the fundamental and technical conditions to advance further. From a technical perspective, the June 2007 level of 124 (yen per dollar) seems a likely next target heading into 2015 (Figure 2).
Lastly, the central bank policies of the U.S. and Japan may differ quite substantially in 2015. As the FOMC prepares to raise the fed funds rate at last, the BOJ may embark upon a third round of monetary easing to offset a late 2015 consumption tax increase.
In my view, the election that has mattered most to investors and the capital markets occurred in Japan nearly two years ago. I expect that in 2015 investors will need to observe the developments in Japan carefully as they will continue to be a leading catalyst for the direction of global risk assets.
Figure 1: U.S. Dollar/Japanese Yen Exchange Rate, Last Three Years
Figure 2: U.S. Dollar/Japanese Yen Exchange Rate, November 1996 – Present