Transcript
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Speaker: Hello and welcome to Under the Banyan Tree, where we put Asian markets and economics in context.
Speaker: I'm your host Harold van der Linde, head of Asian Equity Strategy at HSBC and today we focus on a unique economy and its central bank.
Speaker: Kazuo Weida has been named as the next governor of the Bank of Japan.
Speaker: We're going to bring you all the info you need to understand the nuances of Japan's economy and the Bank of Japan, the BOJ.
Speaker: Plus, key questions on interest rates, wages, currency and equity markets, all of which are crucial to shaping the country's macro outlook for years to come.
Speaker: My guests today are James Lee, Chief Japan Economist here at HSBC, and Joey Chu, our Head of Asia Forex Research.
Speaker: Japan may be famous for its cherry blossoms, but our conversation starts right here, under the banyan tree.
Speaker: So James and Joey, thanks for joining us on the podcast.
Speaker: Thank you very much.
Speaker: Thanks, Harold.
Speaker: Before we get this conversation started, maybe we should first have a little bit of background on WEDA and the Bank of Japan.
Speaker: This new governor is a former member of the Central Bank's policy board, so they determine what they do with interest rates.
Speaker: It's a very important position.
Speaker: And the first post-war governor with an academic background.
Speaker: It is also the first change, I believe, in about 10 years of the governor.
Speaker: And the previous one had set a policy in place that we'll talk about in a second.
Speaker: Because the Japanese Central Bank is well known for its easy monetary policy stance over the past decade.
Speaker: What does that mean?
Speaker: The Japanese said we need to try to enliven our economy again so they keep interest rates pretty much at zero levels.
Speaker: So if you put money into the bank, you don't really get any interest on it.
Speaker: And the idea is that you maybe spend that for.
Speaker: Now, that has major implications because other countries didn't do so.
Speaker: So if the interest rates in the US or in Europe go up,
Speaker: A Japanese saver will say, I'm going to put my money into euro or into US dollar because I'm going to get a high interest rate there.
Speaker: So by doing this, whatever happens with interest rates in the other parts of the world means that people will move money out and therefore the yen will depreciate.
Speaker: Or if those interest rates come down, appreciate.
Speaker: The yen will move.
Speaker: And that has major implications for businesses.
Speaker: Now, investors will be keeping an eye out for signs from Ueda.
Speaker: Are they going to change this?
Speaker: And it comes against a background where Japan's inflation rate for January came at 4.3%.
Speaker: Now, that might not sound high compared to some other economies around the world.
Speaker: Actually, in Japan, it's one of the highest readings we've seen in more than 40 years.
Speaker: So this is quite significant.
Speaker: Ultimately, the BOJ wants to bring inflation down to 2%.
Speaker: Now, having said this background, let's first ask then James, our economist here.
Speaker: James, that policy they had on very low interest rates for the last, give or take, decade or so.
Speaker: Why did they have that policy in place?
Speaker: Thanks, Harold.
Speaker: So just a little bit of background.
Speaker: In the late 80s, the Japanese economy was booming.
Speaker: They had asset prices go higher.
Speaker: However, in 1990, the asset bubble burst.
Speaker: This was together with a rapidly aging society.
Speaker: And what happened in the next three decades was that they had pretty low growth and they had very low inflation for a long period of time.
Speaker: So if you look at Japan, the current price target is 2% increase of prices every year.
Speaker: However, in the past 10 years, they've only had 0.5% increases.
Speaker: Now, what has happened during this 30 years of low inflation is that
Speaker: People now actually think that inflation will be permanently low in Japan.
Speaker: This is something called the deflationary mindset.
Speaker: And when Prime Minister Abe took place, he came in with a policy called Abenomics.
Speaker: This was supporting the economy through monetary policy, also fiscal policy, as well as structural reforms.
Speaker: And part of that policy was for the BOJ to support or provide accommodative policy to raise inflation towards the 2% target.
Speaker: Okay, so that's good.
Speaker: It seems to work therefore because inflation is a bit higher now.
Speaker: So what is happening in the Japanese economy at the moment?
Speaker: So as you mentioned, inflation is at a multi-decade high.
Speaker: Now here we got to distinguish a little bit.
Speaker: Sometimes inflation moves higher because your economy is growing.
Speaker: People want to buy more things and there's scarcity of that.
Speaker: We call that demand side inflation pressure.
Speaker: Sometimes inflation simply goes up because there's a war.
Speaker: Oil prices go higher.
Speaker: Food prices go higher.
Speaker: And that's what we call is supply side inflation pressure.
Speaker: The problem with the current inflation dynamic is that a lot of it is supply side.
Speaker: It is because oil prices moved higher, commodity prices moved higher, and the yen depreciated substantially.
Speaker: And as a result, we as well as the Bank of Japan believe that the current level of very high inflation is unsustainable.
Speaker: So what the BOJ is really trying to get is sustainable inflation, not temporary inflation because of supply side pressures.
Speaker: Okay, so that number that I mentioned, 4.3%, really high, but maybe you can't take that just at face value.
Speaker: That's what you argue, right?
Speaker: Yes.
Speaker: So do you think that with that new governor now coming in, that they will make changes to that policy of keeping interest rates really low?
Speaker: So the answer, I mean, our view, and there's a lot of uncertainty around the outlook at the moment, is that it's yes and no.
Speaker: So on one hand, if you think about Japan's policy setup, usually in most countries, they only determine one rate, which is the very short term rate that impacts the economy.
Speaker: In Japan, in order to provide more powerful support to the economy, they determine the short term rate as well as the tenure rate in the economy.
Speaker: Now, our view is that they'll have to adjust their easing in the tenure rate to make it trade in a wider range.
Speaker: Because there's simply not enough government bonds that the central bank can buy.
Speaker: However, raising the front end rate from its negative interest rate policy right now will require sustainable inflation, sustainable wage growth, which we don't think will happen this year.
Speaker: On this point of sustainable wage growth, I've been reading on the news that companies like Uniqlo raising rages by like 40%, Nintendo, Sony, Honda.
Speaker: Toyota, I think.
Speaker: Yes, that's right.
Speaker: So is this not sustainable in your view?
Speaker: Is that a risk?
Speaker: Yeah.
Speaker: So wage growth for the Bank of Japan to reach its target should be around 3%.
Speaker: What this implies, and if you think about Japanese corporates, what we find is that the labor markets are very rigorous.
Speaker: So we have these terms called lifetime employment.
Speaker: So
Speaker: In the Western economies, when you make a hiring decision, you base it maybe on the next couple of years, next decade, because you can adjust your labor force.
Speaker: However, in Japan, you have to base that on the next 30 years, because once you hire someone, that he or she will stay in the company for a very extended period of time.
Speaker: So when we look at the wage growth data and Japanese corporate behavior is that they don't determine wage growth based on simply, oh, we had one year of high inflation.
Speaker: Let's raise wages like in other countries.
Speaker: It's more of, OK, do we really expect the next 30 years to have high inflation?
Speaker: And as a result, we need to increase wages.
Speaker: And if you look at measures of inflation expectations or how people perceive inflation in the long run, that has not moved higher.
Speaker: And that's why we don't think wage growth.
Speaker: We will see it in certain industries that benefit from, say, the weaker yen or have profited from easy monetary policy.
Speaker: But economy wide, we don't expect wage growth to accelerate enough for the central bank to exit its policy.
Speaker: Okay, well, thanks, James.
Speaker: So there will be some changes to the policies, but it doesn't look like there's revolutionary changes here.
Speaker: Joey, for you, what does this mean for the yen?
Speaker: Right.
Speaker: So during the time when the Bank of Japan was easing policy, the yen depreciated very sharply.
Speaker: So naturally, if the Bank of Japan is no longer doing that kind of policy, then the yen should reverse.
Speaker: And indeed, I think we already saw that in December when the Bank of Japan made one small policy change back then, and the yen appreciated very strongly against the dollar.
Speaker: So as and when there could be another change again, the yen could do another round of strengthening.
Speaker: That being said, the broader dollar environment is also very important because in December, the dollar was weak, but now the dollar is a little bit stronger.
Speaker: And so the yen's impact may not be as large as it was in December.
Speaker: Overall, we still think that the yen should appreciate this year, not just because of the Bank of Japan's changes, but also because of the yen's undervaluation.
Speaker: Now, this has got implications for the rest of Asia as well.
Speaker: There are other currencies that are closely aligned, I believe, with the yen, right?
Speaker: What are those implications?
Speaker: So, you know, in the, I would say, 80s, 90s, maybe in the early 2000s, the yen was very influential for Asian currencies just because of its sheer export connection to the rest of Asia.
Speaker: But over time, you know, China is now the largest export trading partner.
Speaker: So the influence of the yen has naturally gone down.
Speaker: Still, we can see certain currencies like Korean won, Thai baht, even Sing dollar have a little bit more correlation or more relationship with the yen than the others.
Speaker: Thai baht, that's because of the automotive industry.
Speaker: Yeah, that's right.
Speaker: So Japanese manufacturers, a lot of them, the car companies are in Thailand.
Speaker: So these currencies could appreciate slightly alongside the Japanese yen if that happens.
Speaker: But there could be even bigger implications here, right?
Speaker: As I mentioned earlier, because interest rates are zero.
Speaker: So if you're a saver in Japan, you didn't get anything on your deposits.
Speaker: So people put their money into euro, into US dollars.
Speaker: So they were providers of capital to the rest of the world.
Speaker: Is that going to change now if these interest rates might move a little bit higher in Japan?
Speaker: The Japanese en masse are going to withdraw their monies and leads to collapse of financial markets elsewhere on the planet?
Speaker: I think we already saw that Japanese investors did repatriate some of their foreign investments last year.
Speaker: So they sold a lot of foreign bonds, U.S. bonds, and repatriated back onshore.
Speaker: That in itself, I do not think really caused a lot of financial market turmoil.
Speaker: Even though US Japanese investors are very important and very large, the fact is that they mostly invest in US bonds and the US debt market is the largest financial market in the world.
Speaker: So it is unlikely to be just affected by one player.
Speaker: And there are many other factors involved here.
Speaker: Speaking of capital flows, I mean, we're talking a lot about interest rate, which is determined bond inflows or outflows.
Speaker: But actually, the Japanese yen's movements also affect equity markets in Japan.
Speaker: And that could in turn lead to inflows and outflows out of the Japanese stock market.
Speaker: What is your take on that, Harold?
Speaker: Yeah, absolutely.
Speaker: This is quite important because if the yen, for example, depreciates, it becomes cheaper for foreign investors.
Speaker: Therefore, the Japanese equities become much cheaper in US dollar terms.
Speaker: So that's a key consideration for them to invest in that market.
Speaker: But what is equally important is what happens within the market, because if your yen falls...
Speaker: That is good for exporters because they produce in yen and for a foreigner to buy that product is certainly much cheaper.
Speaker: So if the yen falls, the exporting companies, think about technology companies and cars, they do better.
Speaker: While the importers who buy stuff in the US, that's more expensive in yen terms.
Speaker: So they will not do very good.
Speaker: If the yen then suddenly becomes stronger, as you said, for example, we saw this in late last year, then, yeah, that's good for the importers and bad for the exporters.
Speaker: So you see that shift in the market taking place.
Speaker: And in addition to that, there's a lot of Japanese banks.
Speaker: If interest rates move up a little bit, you know, it might not be that much, but that's good for them because, yeah, they, at the moment, they have to deposit money with the government and don't get any interest on it.
Speaker: If that interest rate go up, suddenly the yen,
Speaker: profitability in the banking sector will be much stronger as well.
Speaker: So this has all got major implications for equity markets.
Speaker: But it seems like it's very difficult to say whether equity markets as a whole will benefit or not, and so whether there will be inflows in total or not.
Speaker: Yeah, that's difficult to say because there's so many different factors here.
Speaker: But what you do see is, I think, within the markets, you'll see these sectoral shifts that I just mentioned.
Speaker: So that's maybe one way of really looking at it.
Speaker: So let's recap.
Speaker: Japan has had over the last, well actually more than decade, had a very low interest rate policy in order to revive their own economy.
Speaker: That had happened to a certain extent.
Speaker: Inflation is back, wage growth is back, the headlines suggest that.
Speaker: Although as James said,
Speaker: Those headlines are probably exaggerating the picture to a certain extent.
Speaker: If you look at the underlying data, maybe not as much.
Speaker: There is a new central bank governor.
Speaker: He might well, at some point in time, change this policy.
Speaker: The market is anticipating this, but it doesn't look like we're actually going to make a big U-turn anytime soon.
Speaker: Now, this has implications as we spoke with Joey, not only for the currency markets in Japan, but also across the rest of the region, Singapore, Thailand.
Speaker: So we have to see how the Japanese are going to proceed forward with this over the course of the next couple of years.
Speaker: But at least we understand now how to analyze and to think about these changes in Japan.
Speaker: And on that note, Joey, James, thank you very much for joining me.
Speaker: Thanks, Harold.
Speaker: Thank you.
Speaker: My pleasure.
Speaker: Well, ladies and gentlemen, we're going to have to wrap things up here.
Speaker: Thank you very much for joining us.
Speaker: Remember to check out our sister podcast, The Macro Brief and the ESG Brief, wherever you've been listening to us today.
Speaker: And tune in again next week for another edition of Under the Banyan Tree.
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