Japanese PM Abe needed a bad GDP report in order to justify calling off the tax hike, and he got more than he bargained for. Japan’s Q3 GDP declined 0.4% q/q, well below the consensus forecasts for a gain of 0.5% q/q, while y/y rate fell 1.6% versus expectations of a 2.2% increase. As GDP contracted for two consecutive quarters, it qualifies as the fifth Japanese recession over the past six years, interspaced by short-lived quarters of modest growth rebound. PM Abe will not only be able to delay the much-feared sales tax hike, but also likely to call snap elections later this year to guarantee a majority for an additional five years and secure support for further stimulus programs. Regardless of any upward revisions seen at next month’s GDP revision, the Abe government will likely go ahead with its plans to call an election and postpone the consumption tax. Yen weakness is far from over.
Pressure shifts from Kuroda back to Abe
PM Abe is expected to make an announcement on the election either on Tuesday or Wednesday this week. Unconfirmed reports suggest December 14 or 21 as a preferred date for an election. This raises the question as to what will be the next step from Abe’s Liberal Democratic Party. Asking the Bank of Japan to further step up purchases of bonds and ETF is unlikely since Kuroda’s BoJ narrowly passed an increase in QE less than two weeks ago. This leaves matters in the hands of politicians, with Abe’s cabinet likely to announce supplementary budget (another one).
Here come the rating agencies
We expect Moody’s or Standard & Poor’s to downgrade Japan, or at least issue a negative watch before year-end, as Abe impacts tax receipts by not only cancelling a tax hike but also increasing spending. Both Moody’s and S&P have not changed their rating outlook on Japan since 2011, while Fitch last change was a downgrade to A+ from AA in May 2012.
USD/JPY isn’t done yet
We said here and here that the combination of yen-depreciating QE expansion from Japan and a second round of Targeted Long-Term Refinancing Operations from the ECB, will likely cushion risk appetite at the expense of the Japanese yen, only this time the biggest beneficiary will remain the USD/JPY. As we approach the minutes of the October FOMC meeting, USD bulls may sustain short-lived pullback by additional words of concern on the impact of USD strength. The chart below show the continued positive correlation between USD/JPY and the Nikkei-225 as yen weakness boosts Japanese equities, but the usual positive correlation with US-Japan 10-year yield spreads seems to be lagging. Whether a pullback in USD/JPY will extend to 114.50 or 113.80s, the pair is far from the nine-week consecutive gains attained in Q4 of last year. 117.05 may have been tested, but 120 looms as early as this month.
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