Masahiko Loo sees Sanae Takaichi, getting ready to become Japan’s Prime Minister after winning the presidency of the ruling party’s recent election, coming in on very strong footing.
Yes it’s excting that Japan, another major developed nation with the world’s third largest economy, has elected it’s first female leader. More importantly, he notes that she is considered by many to be a “mini Abe,” a person who not only comes from the same prefecture as Shinzo Abe, Japan’s longest-serving prime minister, but also was his political protege who has held top positions in government and in the ruling party. She is seen as an Abenomics disciple who supports expansionary economic policies including more government spending and tax cuts, who has openly criticized the Bank of Japan’s interest rate hikes.
Despite what policy steps Takaichi would like to take, Masahiko points out that she will be constrained by many different forces. On the political side of the equation the ruling party which Takaichi leads is in the minority in both the upper and lower houses of the National Diet, the first time the LDP has lost its majority in both chambers since its founding in 1955.
And he points out that Abenomics’ success in getting Japan out deflation and the economy on to a steady growth path, with its extraordinary monetary stimulus and aggressive fiscal stimulus, means that Takaichi is taking over “in a very different world’ where the BOJ is hiking rates on its path to normalization,” and that aggressive fiscal steps are not needed. In fact, he points out that Takaichi is now talking about responsible fiscal spending, ostensibly “to calm the market.”
So dive in and hear why Masahiko says Takaichi will not try to stop the BOJ from doing its next rate hike but will urge it to move carefully and slowly to do more rate hikes next year.
And hear this Tokyo-based, globe-trotting fixed income strategist explain, complete with facts and figures, why Japan does not have a debt sustainablity problem in large part because Japan owns the majority of its government bonds. He also looks at the yen’s depreciating trend and argues that it will be sustained, and assess the levels that could spur FX intervention if the downtrend continues. And he offers insight on where Japanese government yields are heading and what will drive them.
Japan’s first female PM &An Abe Protégé 00:02:08.660
I think the movie’s general very positive, right? I mean, like, she’s the first female, in history that… in Japan to become the Prime Minister of Japan. And of course, you know, she has a pretty strong, you know, charismatic, style, right, in terms of when it comes to, politics and governing, and she has a pretty strong track record of achieving what she wanted. And, of course, remember, you know, a lot of Japanese, voters, right, they were favoring, the late, you know, PM Abe, and she is pretty much related to Abe. They are both from the same prefecture. You know, think of them from the same hometown, and, she’s basically a protégé of Abe, and
Mini Abe? 00:02:50.360
I wouldn’t be, you know, surprised if people call her, like, a mini Abe, and if you look at the people surrounding her, a lot of them, you know, especially the political aides and also the economic advisors, they are all, you know, from the old Abe camp. Where, you know, it’s more of a conservative style, and then a better leadership style in terms of, you know, politicking and governing
The ABE policy success and tilt 00:04:02.150
I think taking a step back, right, Abe, you know, the PM Abe had done a tremendous job in getting Japan back to its, you know, its level, right, that it can be at par with its developed market peers. Right? Japan had a stacked in 30-year lost decades, right? And then, if you look at Japan, the growth recently has been. If not anything, one of the highest among, G7, right? And even for its inflation, right, headline inflation, we’re talking about headline, is above 3%, for, you know, 3 years consecutively. Core inflation-wise, you know, the global style, or U.S.-style inflation, X energy, ex-food, is still around 1.5%, and
Abe’s Three Arrows and Takaichi 00:04:47.260
When Abe came in, you know, remember, he implemented the three arrows, right? Namely, monetary, fiscal, and also the third one, which is structural reform. Right? Which didn’t really pick up that much, but then the first two arrows you know, were in full force, and when Takaichi-san, the new… Upcoming PM, when she comes into, the PM role is… we are in a very different world now, right, where Japan labor forces, you know, the labor shortages are there, but then, the labor participation rate is up versus what Abe had in the past. And also, you know, monetary policy-wise, you know, we have seen Abe go all out, and now we are in a very gradual normalization path, and I think this is where, you know, a lot of investors, think, very differently, right? A lot of, this plus money type of flows thing that, you know, Takaichi’s going embrace or embark another full Abe agenda, which we think, you know, there is a bit of constraint and a bit of differences versus what Abe administration had back then.
The path ahead? 00:06:45.440
Okay, I’ll break it into two parts. First, regarding the fiscal policy, right? Second part, regarding the debt sustainability of Japan. Number one, when it comes to fiscal policy, I think that, you know, she has toned down a lot, obviously, from what she was campaigning last year, that she wanted all our fiscal spending. Which is not a bad thing, remember, right? If you look at the US, right, because of all this fiscal spending, U.S. has managed to inflate a bit of the debt away. That is happening in Japan, too, right? If you look at the GDP…debt-to-GDP in Japan has came down from 250% to 240%. That’s the gross, right? I will touch a bit on the net, debt-to-GDP in Japan later, on the debt sustainability,
Political pre-conditions needed are absent 00:07:24.610 narrative, but then remember, fiscal policy-wise, you need a majority in both chambers in Japan, right, when it has the lower house and upper house to pass all the spending packages, right? But this is where Takaichi-san doesn’t have. Right? Because LDP, her ruling party, only has minority, you know, in both chambers, right? So she would need to work with the competition, and it’s not a very easy task for her to go all out and spend whatever money she wants, right? That’s why she has toned down, she has since talked about responsible fiscal spending, and obviously, to calm the market, she has actually, appointed, several fiscal discipline beacons in the Cabinet, right, to be in, senior positions within the LDP, namely, Mr. Aso, which is the ex-Prime Minister, you know, the, Minister of Finance, and also, Suzuki, which is also, you know, the Minister of Finance previously under Kishida, and both of them are known for, you know, their fiscal discipline stance. So to me, you know, fiscal spending, we will have a bit of loser fiscal spending, but not to the extent of, you know…There’s no end-of-the-world fiscal spending.
Debt sustainability 00:08:50.170
And then, connecting that to, debt sustainability in Japan, number one, Japan doesn’t have a debt sustainability problem. Right? Just… 90% of Japanese JGBs are all funded locally.Japan household has twice the GDP, you know, financial assets versus what they have GDP. They have, around 2 trillion yen worth of, financial assets, so which is cash and equivalent sitting in their bank account or cash, right, floating around, so there’s no problem. Number two is, like. Number two would be the debt… gross debt-to-GDP in Japan is 250%. It’s very well known, everyone is alluding to that. But if you look at the net debt-to-GDP in Japan, it’s only 140%, and it’s on a very improvement… improving trajectory. I think the latest number out is, you know, moving towards that 100%. And as a comparison, U.S. gross debt to GDP is 120%. And their net debt-to-GDP is 110, so that’s only 10% difference. And where does all this Japan, you know, 100% difference come from? Remember, Japan has this, you know. humongous, pension fund, GPIF.
Japan a net creditor nation 00:10:22.340
Japan has, the… their foreign reserves, right, which is one point…to $1.3 trillion, and obviously Japan still has a lot of, you know, assets and quasi money sitting around. That’s why you see… and last but not least, Japan is the largest net creditor in the world. Amounting to $3.7 trillion, so that’s a lot of money sitting around there, and, you know, that’s why, if you look at the net debt-to-GDP ratio, G7Y is Japan is in a fairly good shape, and it’s actually improved
No Truss moment in Japan 00:11:48.860
Which means that the previous Prime Minister Truss in the UK, which lasted then, I think, around a month, right, in her position, announced, like, a big fiscal spending package, which, you know, the bond market really didn’t like it. That’s why, you know, that’s triggered a lot of sell-off. And that sell-off basically, you know, transformed into a virtual cycle. Japan versus UK are very different animals, right? UK, if you look at the historically, one has relied a lot on foreign funding to fund a significant portion of its government debt and the broader economic activity. Long twin deficit.
Japan’s circumstances are quite different and insulating- 00:12:34.960 Japan on the other way around, right? Up till a couple years ago, Japan has a pretty strong, current account, surplus. And remember the $3.7 trillion, net creditor asset, external asset that Japan has? The higher the yield overseas. , being able to inflate a bit away of that debt just because of… they have a pretty negative real yield. We’ll touch on that later, right? And also, the pension system in Japan is very, very different from the UK where, you know, there’s key differences in both systems, most notably valuation methodology and derivative usage. I won’t go into details, but, you know, long story short, Japan, that won’t have, like, a shock of what UK had, because the pension funds here are all investing in cash, securities, cash-bonds, right? There are no derivatives involved, so when, you know, when you leverage, when you lever up, when there’s sell-off, you know, you get margin call, you have to sell some assets to basically, you know to top up your margin, but Japan doesn’t have that problem, right? So I don’t think we will see, like, a Truss moment in Japan.
It comes back to some version of the Abe moment 00:15:04.240
Look, I think market is, again, thinking that, you know, Takeaichi coming in will be like Abe, and then will reframe BOJ, and, you know, and not allowing them to hike. We are in a very different world, right? When Abe came into power, Japan was having constant deflation…Yeah. Right? Now, we are having headline inflation, right? 3% for three years consecutively, right? So we are in a very, very different environment, and when it comes to, you know, fiscal spending, there’s < a difference>, when… during Abe’s time, you know, there was quite a big package being announced, and Kishida Nomics and, Ishibanomics, which is the previous two prime ministers, they were pretty much, you know, very pro, authority, so there’s less fiscal spending, and then, with weaker yen, imported, inflation in Japan, that’s why we have discontent, right, discontent of the citizens in Japan. That’s why, you know, you see them, suffering losses in both elections, in the past two years. And with Takaichi coming in, and I believe that you are alluding to, Mr. Etsuro Honda, which is the, you know, advisor, senior advisor for Andre Abe, and he was one of the main architects for Abenomics, together with, you know, the emeritus professor from Yale University, Hamada…
Let’s imagine a scenario…00:16:44.680
Professor Hamada, we call them… we call him Hamada, let’s say. I think you have interviewed both of them, Honda and Hamada, right? And Honda was basically talking about, you know, one or two more hikes, right? And that’s the whole rhetoric, right? They are not… banning or not constraining BOJ not to hike. What they want here is to, have a slower path, or, like, a more, of a more disciplined or more conservative part for… part… path from BOJ on that hiking cycle. And if the data, is alright, you know, if you see the inflation, keep on coming in, on a very, positive trajectory, and also the wage growth in Japan, we call it Shinto negotiations in Japan.
Takaichi will seek moderation from BOJ policy not control 00:17:15.010
Masahiko Loo: hitting, you know, its record high for a couple years consecutively, and then if we do have… this is the most important part, which is the real wage growth, right? So, wage growth, salary, whatever incremental amount you get of salary minus inflation is…positive, then that’s a good sign, and they will allow BOJ to hike gradually. But again, you know, we are talking about a thermal rate of 1 or 1.25% here, so it’s not… Too far from what they have now. Which is 5%.
Moderation in policy from the BOJ not control 00:18:57.190
Right, I think the previous administration, right, namely Kishida and also, Ishiba, they are, more okay, or leaning toward, giving the BOJ a free hand; I think, like, Takaichi is more hands-on. She would prefer an overly cautious BOJ, let’s put it that way. She’s not going put full force on the BOJ, forcing BOJ to do something like, for instance, easing. That is not what she will do. But she would prefer BOJ to be more cautious when it comes on hiking, for instance. Especially when you are, talking about, you know, we have been suffering from three decades - lost decades - and also deflation! I think Japan is one of the only nations globally that has suffered this, right? And then, just because of this population, demographics, and deflationary, you know.
Fear of deflation still haunts Japan…a mindset 00:19:52.050
This mindset being well ingrained in everyone’s mind. That’s why you have seen Japan, the core inflation, which is the US-style inflation, or global-style inflation, X energy, X food, is only 1.5% versus the headline inflation, around 3% in Japan. A lot of it comes from, you know, one-offs, and goods inflation is actually very high in Japan versus the services inflation, right? So goods inflation is very high versus services. That’s very different from what you see in the UK or US, right?
Purchasing Power Parity ,according to baristas, favors Japan 00:20:25.700
I’m now in London, and I was shocked of, you know, how much more expensive. Like, a cup of coffee is, like, $7, right, in the US, and it’s £5 here, which is double the price in Japan, so if any one of you planning to come to Japan and to visit Japan, Japan, this is a great time, because Japan is almost half price, right?
A defense of gradualism 00:20:45.290
And we do not have an inflation problem, per se, versus, you know, other developed markets. That’s why I think Takaichi wants the BOJ to be, leaning more towards the cautious side, and if the data allows them to hike, you know, they will hike gradually, right? I think that’s the main message here.
Policy cycle is still the Fed’s story 00:22:11.880
I think yen, you know, ultimately is still, like, a Fed story, it’s a U.S. story, right? More than a BOJ story, right? Just because of the real rate in Japan is less… we discussed about it, right? It’s 1% or 1.25, you know, give or take, right? But the U.S, rate, is coming down from… all the way from 5.5 to around, like, 4.25 <4.00% to 4.25%>now, right? So, if we do have, like, another, you know, several, say, like, two cuts being priced in the market, we think we… our house view, we were calling for three cuts, earlier from this year, so we haven’t changed our house view at all.
The Fed: three cuts then …uncertainty 00:22:44.220
The Fed is actually embarking towards the direction, right? Three cuts this year. Next year, you know, we have a bit of less conviction, but then we think a ballpark of two, maybe three cuts, right, continuing to next year. So if we do get that trickle into the, U.S, you know, Federal Reserve Fund rates, that will bring the rate differential… of Japan versus U.S. down.
Currency impact of central banks on different paths 00:23:08.890
A lot, right? And just because BOJ will hike twice, and the Fed will cut, you know, say, 4 to 5 times ballpark, right? And that will, I think, you know, long… mid to longer term, next year, 2026 year-end target will be 135 versus 150.
The ‘carry’ trade ..is it getting heavier? 00:23:22.950
In the near term, we know that… we noticed that, of course, there’s a lot of, volatility, there’s a lot of speculation in the market, and people are still wanting to, short yen because of… it’s one of the best, carry trade, right, year-to-date. And not to mention, you know, 152 was the level that, you know, the Minister of Finance MOF in Japan, was, you know, they drew the line in the sand.
Wary of knock-ons: fiscal à monetaryà yen 00:23:47.120
For the past couple, interventions that we see, namely last year, and then it was, I think it was 2023, that they came in and intervened in the market. So, you know, I think that level 152, 155 is a good level to watch, right? And we are pretty much very close to that, and I don’t think, you know, Takaichi… I think she’s watching it, the market pretty closely now, right? Because she has all these, advisors around her, too. That’s why she has toned down a lot of fiscal dovishness, let’s put it that way, right? And she has installed, so she has, appointed Suzuki into that key LDP position to reassure investors or, you know, the market of, their fiscal, disciplined stance, responsible fiscal spending. They will spend, but then spend responsibly. So, you know, in other words, you know, 150 in the near term, maybe a bit of overshoot, but then mid to longer term, we think it will go back to 135.
The final stages in flux to establish a new administration 00:25:14.710
With now, without a real PM up there yet, right? She is negotiating, and then with the, opposition, or the coalition, and she’ll form government later this month. I think they need…a clear, communication…channel being set up with BOJ and also the MOF, right? And, I think that will require at least a month or two, right? Maybe… a bit less, if we do have a lot of volatility in the market. But then that’s why we think that, you know, October’s rate hike is technically out of the equation now, unless yen overshoots a lot to one, you know… We think that, you know, December, January is probably likely.
Markets as QE shifts to QT 00:26:28.810
JGB is trading, what, 1.65% now, right? I think the range is going be 1.5% to 2%. why am I talking about this, right? Just because of, you know, pre-Abenomics. 10-year JGB was trading around that range. And think of what happened during Abenomics, right? So, BOJ has bought 50% of the outstanding JGBs in the market. They’re in the process of unwinding that. Namely, QT, right, quantitative tightening, right? Back very gradually to the market, and there’s always a question, who’s going buy them, right? Remember? Who did they buy them from to begin with, right? So BOJ has bought all the JGBs. 10 years ago, right? For a period of ten years from Japanese banks. Right, Japanese banks have… around 400 trillion yen, so let’s say ballpark, you know, around ¥3 trillion sitting in cash in BOJ. Right? So, when you have a gradual QT, I think, you know, that basically, you know, buyer’s mechanism is going to be transferred from BOJ to the banks. And banks are a sensitive yield buyer. BOJ is insensitive.
Bank benchmark buying rate - 00:27:48.660
10-year JGB could go towards, you know, closer to 2%, namely 1.82%. I think a lot of these banks will happily come in and buy. And don’t ask me why, Japan has a very big herd mentality movement, where, you know, they look at, you know, their peers, and someone. One of the big boys started buying, everyone was rushing and…This is very Japanese, don’t ask me why, but then, you know, this is… I think the point here is, you know, there’s… A bit of, you know, potential, leeway to go for the yield to drift a bit higher from here, but then there’s also a cap here, just because of, you know, there’s cash sidelines in the system, and now, just because of domestic not participating actively, you have more foreign, fast money type of investors driving the market. That’s why we have seen a lot of this volatility in the past couple months, and also, you know, yesterday.
Fund repatriation prosects are lean 00:29:07.650 I wouldn’t… I couldn’t be, like, a broken record here, but, you know, there’s always a question on… with BOJ… I’m sorry, with JGBL drifting a lot higher, will the Japanese investors repatriate and sell all of foreign assets, come back to Japan? The answer is no. Japanese investors own, they own $1.2 trillion of U.S. Treasuries, and the majority of that owners are structural holders, namely the, you know, foreign reserves, the pension fund in Japan, GPIF, and, you know, there’s a lot of this structural money, holding U.S. Treasuries that they are not selling, in other words.
Keep calm and carry on 00:29:49.560
While, you know, the yield-sensitive buyers, you see a bit of technical, trading here and there, but then they’re all RV players, so, you know, relative value player. If we do see sell-off in JGB, they’ll buy JGBs, and then if JGB rallies, they’ll, you know. get the money out, and then invest in US Treasuries, or Boons, or someone else, or German… Boons is Germany, you know, bonds. So, in other words, you know, keep calm and carry on. Japanese are not going to sell all the US treasuries they hold. If anything, they will hold it for a very, very long period of time.
Masahiko Loo is a Senior Fixed Income Strategist at SSGA. Prior to joining SSGA, he served as an Investment Director at Wellington Management representing its Fixed Income franchise. Before that, Masa was Head of Japan Fixed Income and Asia-Pacific portfolio manager at AllianceBernstein. He began his career in Fixed Income at J.P. Morgan. Masa is proficient in six languages, including Japanese and Mandarin, and holds a BA in International Liberal Studies from Waseda University.
