Tag Archives: politics and exchange rates

Japanese Election: Stocks up, Yen down

Discussion and Analysis by Charles Porter:

 

The triumph of the Liberal Democratic Party (LDP) and Japanese Prime Minister, Shinzo Abe, over the weekend has driven the Japanese stock market skyward and the exchange rate downward. Whilst the certainty of a freshly mandated national government usually affords a domestic currency with value, the specific brand of PM Abe’s premiership explains the Yen’s downturn. Following our analysis preceding this weekend’s Japanese election on a Liberal Democratic win, we revisit the election result.

 

Yesterday, the Japanese public headed to polling stations across the nation to elect its 48th House of Representatives. The snap election, the fourth that Abe has successfully contested, provided a mandate for the incumbent coalition between the LDP and the Komeito party to resume governing through its super majority. Achieving more than 310 seats within the 465 seat House, the coalition has the potential to, and will, control over two-thirds of the house. The democratic result seals the deal for Shinzo Abe to aggressively pursue his preferred policy path.

 

The abnormal circumstances surrounding the election, notably its surprise timing and the idiosyncratic decisions made by its candidates, has been joined by further abnormal effects within equity and foreign exchange markets. The consolidation of a likely result usually rewards the domestic currency with greater value and, dependent upon the preferred policy stance of the successful candidate, allows concomitant gains for the associated equity market. However, this has certainly not happened. The Japanese stock market has rallied, with the Japanese Yen steadily losing value up to and following Abe’s success.

 

For a candidate that is putting the economy, and secondly the consolidation of national democracy, at the forefront of his now certain premiership, a devaluation of the national currency following an above-expectation result is certainly extraordinary. The reason concerns Abe’s addressal of the systemic Japanese macroeconomic problem.

 

The problem, as Princeton and Nobel Prize-winning economist and Japan specialist, Paul Krugman, points out is the deflationary pressure and low growth that the Japanese economy has endured for decades. Periods of severe deflation, an extremely concerning and eschewed macroeconomic reality, have gripped the Japanese political economy sporadically throughout the period. The solution that Krugman points to is an increase in the money supply and general stimulus; big time.

 

The Bank of Japan has this capacity. Either through the rapid acquisition of vast amounts of governmental or private debt, the Bank can increase the money supply, thereby increasing the lending facility of private banks, financing government expenditure, and generally increasing the availability of credit and the circulation of money.

 

This brand of macroeconomic and political guidance is exactly that endorsed by the successful candidate, Shinzo Abe and the Liberal Democratic Party. Whilst this may ultimately be what Japan needs in the long-run to finally escape its deflationary and recessionary pendulum, it is nevertheless damaging to foreign exchange markets.

 

Ultimately, the self-branded policy set, “Abenomics” that Mr Abe has begun throughout his previous term amounts to ultra-accommodative monetary policy and fiscal stimulus. Whilst seeking popularity with a trifecta including structural reform and wage growth, the heart of Abenomics is bipartite and consists of monetary easing and government spending.

 

As many of my articles have explained, loose monetary policy leads to a depreciation of the exchange rate by increasing the supply of money and decreasing the reward for investment. The former lowers the effective price of the domestic currency whilst the latter decreases its attractiveness from outside and within; thereby leading investors and savers to look elsewhere for their currency exposure. Therefore, it is ultimately unsurprising that the confirmation of and lead up to Abe’s success was characterised by consistent gains on the Nikkei, the Japanese stock market, and consistent losses for the Yen.

 

A refreshed mandate for this band of Liberal Democratic rule may be positive for the long-run success of Japan; clearly the retention of a super majority goes some way to proving the popularity of Abe. Whilst such accommodative monetary policy may lead to an undervaluation of the Yen for a considerable time, the characterisation of the Yen as a safehaven currency, at least for now, will always leave it with interesting, if uncertain, value.

 

 

USDJPY – the appreciation of the Dollar against the Yen has been pronounced whilst the electoral certainty of another Abe win increased. The brand of Abenomics, relying first and foremost upon fiscal stimulus and expansionary monetary policy, has depreciated the Yen against its counterparts. 

 

Japan’s critical election

Discussion and Analysis by Charles Porter:

 

Parliament is dissolved and the date is set for Japan’s election later this month. A bold political move by incumbent Japanese Prime Minister, Shinzo Abe, now looks likely to achieve its ultimate purpose. The significance of Japan’s election to the Yen cannot be understated. The importance spills over not just from politics, but also geopolitics, economics and the political economic architecture of Japan.

 

The date is set for 22nd October for Japan’s election. As the election result has become more certain in the polls, the upside potential to the election has been priced out of the market, leaving only downside risk of a surprise Abe defeat. This effect is not uncommon as the market reaches a consensus that the base case scenario for the election is a win for Abe’s Liberal Democratic Party. Therefore, this result becomes almost entirely priced in, leaving only dwindling uncertainty as the upside potential upon the election result.

 

So, why is Abe’s win so likely?

 

It’s probably not down to political pragmatism and the assumption that only an incumbent with a guaranteed win would call a snap election. Theresa May’s conservative government proved that well. In free and fair elections, the election result can almost never be certain and the underlying tensions within an electorate can be spun into either a weaker coalition government or oust the incumbent entirely.

 

It is, however, still likely that Abe foresaw a convincing likelihood of consolidating his position within the parliament of Japan’s bicameral political economy. What has more concretely led to the base case of Abe’s success is the apparent disarray of an opposition.

 

There was already wise money on Abe calling a snap election, however, just not so soon. This is because of the apparent present incapacity of the opposition party, the Democratic Party, to provide a viable voting alternative. Perhaps this is why they grabbed headlines early on announcing that they will not field a candidate for the election.

 

Instead, the main opposition party has enforced and teamed up with the Kibō no Tō, the Party of Hope. This party is certainly non-trivial. However, the success and recent popularity of Abe, who has been governing Japan for 5 years now, ought to be sufficient to counteract any swings in public favour towards the Hope Party. The Hope Party is certainly credible and admirable, founded by Tokyo’s first female Governor Yuriko Koike. However, with the tension continuing to mount and spill over from the Korean Peninsula, the proven and moderately successful state-level leadership of Abe is likely to triumph.

 

So why does the election matter?

 

The governing Japanese party arguably has more power over the Japanese economy than many advanced Western economies constitutionally allow. The (central) Bank of Japan’s independence is highly new and has, arguably, seen a moderate retrenchment following Abe’s election to the premiership.

 

Previously subsumed within a state department, the Ministry of Finance, the macroeconomy could be steered from a politically exposed office. Given the salience of the economy to Japan following enduring stagnant inflation, and at times deflation, the politicisation of central banking was not such a bad thing. Many would argue that because responsible and medicinal central banking was a salient voting issue within the Japanese electorate it generated a democratic and binding mandate to pursue economic growth with a lubricating inflation level.

 

Abe’s commitment to monetary stimulus, even within the now more independent central bank makes his election pivotal for markets, and particularly those exposed to foreign exchange. The confidence effect of what has been labelled ‘Abenomics’, his tripartite stimulus and (mild) structural reform program, is critical for Yen strength. With an unproven record of monetary policy, a high salience issue, on the part of the Party of Hope, both the market’s desire and the Japanese public’s support is likely to be consolidated within an Abe win.

 

There is a final and pervasive reason why those exposed to foreign exchange risk, perhaps not even to the Yen, should care about the Japanese election. The Yen is regarded as a safehaven currency, meaning that as uncertainty and risk enter the world environment, the value of the currency paradoxically rises. In effect, the value of safehaven currencies, and thus the Yen, should inversely correlate with the value of other developed currencies and assets.

 

A threat to the political composition and political economic exposure of a safehaven asset, and particularly a currency, can undermine its status. Therefore, a core trading relationship within the Yen could be threatened by political instability and upset caused by a non-base case electoral performance.

 

In summary, the intrinsic link between politics and economic governance, the status of the Yen as a safehaven currency, in addition to the normal tumult caused by an election, all make the Japanese snap election all the more important. A non-Abe, non-Liberal Democratic, result could at this point upset markets meanwhile another term of government is the market base case.

 

Party Conference and Sterling

Discussion and Analysis by Charles Porter:

 

In theory, the Conservative Party Conference taking place in Manchester could boost the Pound Sterling. This is because it is an opportunity to bring all Conservative Party MPs and Ministerial Cabinet Members together and provide a coherent and harmonious vision of their leadership intentions. However, the content, disorder and context behind the Conference over the past two days has undermined, and even reversed, this possibility.

 

Whether Sterling’s performance today is entirely attributable to the Conservative Party conference is highly doubtful. Without reservation, the complex political economy within which the UK finds itself is undoubtedly responsible for the volatility and underperformance of Sterling, to a significant extent. However, it is with similar confidence that I can assert that some of the losses that Sterling has encountered throughout the trading day, across most currency pairs, is partially down to the conference.

 

Theresa May’s Conservative Party proudly grasped the opportunity to demonstrate unity in Florence. By turning up alongside the foreign secretary, Boris Johnson, her secretary of state for exiting the European Union and lead negotiator, David Davis, and the Chancellor of the Exchequer, Phillip Hammond, May signalled a unity amongst key members of her front bench. However, following a widely followed interview with Andrew Marr on the eve of the Conference, May’s leadership capacity within an uncontrollable Cabinet, with “unsackable” members is being questioned.

 

As such, a sign of unity and strength may have awarded credibility to the incumbent government. Leadership credibility boosts the strength of the currency, in this case the pound, because it signals a capacity to achieve regulatory progress and assert control over the polity and economy. May’s speech was a particularly politicised speech, aggravating many watchers and voters by failing to answer directly a vast number of questions proposed to her.

 

Therefore, the reality of the conference so far is surprising and harmful to the Pound. The negative campaign deployed at the conference, one in which the Chancellor, Phillip Hammond, accuses the opposition party of undermining the UK economy without even acceding to power, is not what the party and currency alike need to recover. Therefore, the inverse impact upon the economy and exchange rate occurred; the Pound Sterling trades down against most other currencies, including the Euro and US Dollar.

 

Whilst there is still a considerable portion of the Conservative Party Conference yet to speak, particularly tomorrow’s appearance of Liam Fox, Secretary for International Trade, alongside David Davis, some damage has been felt within the Pound today. Following Davis’ appearance, Boris Johnson, the unsackable Member himself, will speak alongside other noteworthy Conservative Party Members. Political pessimism has been priced into Sterling ever since May’s failure to secure a Conservative Majority within the House of Commons in the snap election. Therefore, whilst UK data releases remain sparse and as the Conference continues, considerable upside and downside risk will manifest making Sterling considerably volatile this week.