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Saturday, September 29, 2007

Finally Some Good News from Japan?

by Claus Vistesen: Copenhagen

This post (together with Edward's last entry on the Japanese trade surplus situation) are the first installments of a series of "new-style" posts we will be having here at GEM. Traditionally has gone for more in-depth, detailed "x-ray crystallography" type, analysis of particular countries, regions or issues. In part this has been done in conjunction with Manuel's excellent coverage of national election processes.

However, since both Edward and I cover rather a lot of ground on a day to day basis, we are going to start bring some of the fruits of this to readers here in the form of short(-ish) research note posts.

The first of these notes is on Japan, and the note is accompanied by a statistics-based charts-appendix from Edward at the foot of the post.

What's With the Japan News, Is it Good or Bad?

On the back of a miserable Q2 GDP reading and general uncertainty in markets Japan's economy has not exactly been the harbinger of pleasant data reading as of late, unless of course you have been short on the Yen. As I said in a recent small post on Japan Economy Watch this week was always going to bring some pretty interesting data releases from Japan in terms of figures for prices, consumption expenditures, industrial production and unemployment. In this short note we will take a look at the first two of these, and as prices, consumption expenditures arrive I will add the perspectives these latter provide in the form of updates to this post. Beginning with prices the overall picture did not change much in August with the reported benchmark index (general index excluding fresh food) staying flat at a -0.1% rate of deflation. The core-of-core which excludes both fresh food and energy rebounded to a rate of -0.2% from last month's -0.5%.

More generally on prices we are moving into rather uncertain times I would say. Despite what may seem evident from today's overall reading of economic data I am still skeptical as to how much internal activity in Japan as such will drive up inflation through internal demand dynamics. However, even if this question is left out we still have what we might call 'second-stage' inflation which has moved somewhat closer to the realms of the CPI basket as of late with production input prices shooting up significantly. In an excellent note over at Macro Man's place you should check out the graph which plots wholesale inflation and although the time series is somewhat too long term to use gauging monthly trends this is definitely something to watch out for. Also, of course we have all that famed 'anecdotal' evidence about how mayonnaise and Starbucks lattes have seen their prices climb. Yet, as I hint above the key here is whether inflation will be able to take hold in final goods markets which is why the core-of-core index will be interesting to follow. The following quote from Bloomberg sums up well this perspective ...

``Unless large retailers start raising prices, Japan's core inflation won't take hold,'' said Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. ``The closer companies are to consumers, the harder it is for them to increase prices.''

So, this is indeed the case in point here and of course what this tells us about the underlying propensity to consume relative to where in fact the inflation pressures (if any) will come from. This perspective is especially important in so far as goes the potential for energy prices to rise quite significantly on a y-o-y basis in the latter part of 2007.

Turning to readings on domestic demand we also from the basic headline reported in the media that domestic consumption expenditures rebounded to a 1.6% increase on a y-o-y basis. Now, compared to recent months' rather sub par performance this is indeed something of a rebound and for good measure I also reproduce the graph below which contains the figures which are widely reported by the media.

However, since we are after all in the business of doing sound economic analysis (aren't we?) we might also want to look at some more solid measures of the trend in domestic demand. First of all it might be a good idea to incorporate some kind of seasonal adjustment to the data series especially since we are now, as can readily be seen from the graph above, moving into a territory where y-o-y nominal unadjusted figures are bound to get some headwind from what is clearly a rather distorting v-shape as domestic consumption apparently tanked in the middle of Q3 in 2006. In this way, why don't we have a look at the index-2005 series which is furthermore seasonally adjusted. As we can see below domestic consumption did indeed climb in August but in any way did it climb to the extent that we are led to believe. In fact, we see that general consumption expenditures still remain on a downward trajectory relative to the beginning of the year.

This point is also further substantiated if we look at the real seasonally adjusted monthly series which again, without a doubt, show that August saw a climb but that the overall downward trend since the beginning of the year is confirmed.

Finally, and to hammer my point down we could also go back through the underlying consumption indicators (Preliminary Report on the Current Survey of Commerce for August 2007) and take a look at sales for retailers, wholesale, and commercial sales. As Edward shows below, retail sales did in fact manage to clip in a 0.5% increase y-o-y but it also worth noting that total volumes of sales actually fell from July. In fact, if we look across the board total volumes of wholesale sales, commercial sales, retail sales, as well as sales from large retail stores all fell from July in total volumes in fact extending 3 to 4 monthly declines for all series. So this is just to say then that behind the reported headlines lies a reality which is a bit more differentiated than is often suggested.

Moving on for a minute to corporate capex proxied by industrial production August saw a hefty uptick but we need to remember that this figure also somewhat has earthquake rebound written all over it. As I have hypothesised in my previous notes there is a risk that industrial production could begin to trend down as we move into the final months of 2007 on the back of the obvious downside related to the continuous specific role played by he Japanese export sector.

In Summary

As a first approximation we could of course ask what effect this is going to have on markets and subsequently the probability of a rate hike by the BOJ? Clearly, if the coming months provide the same kind of upward tendencies we can expect the Yen to come under some upward pressure which especially should be seen in the light of what seems to be lingering Dollar weakness in some time to come. However, if we look at the G3 currencies we are pretty much kept out of the loop by the uncertainty surrounding what exactly the ECB is going to do with both inflation and the Euro on the rise at the same time of course as the economic edifice is crumbling before our very eyes as we move in H2 2007. Interestingly and from a Japanese perspective the Nikkei index actually fell today, despite what was clearly narrated as a bullish news release, on what seems to be the 'structural' outlook in Japan. Note especially the following points:

A fundamental perspective does not favor domestic demand companies, as their opportunities for growth look slim,'' said Hiroyoshi Nakagawa, who helps oversee about $1 billion in Asian equities at Societe Generale Asset Management Co. ``The best bets for outperformance are in companies dependent on China such as commodities, shipping and machinery stocks.''


``Disposable income in Japan is not increasing, and the middle class is shrinking, which indicates that earnings at domestic companies are not going to improve,'' said Societe Generale's Nakagawa.

So it seems that perhaps a new narrative is emerging here in relation to Japanese export dependence which is clearly, at this point, more than a passing trend before the Japanese economy 'normalizes.' Returning to the inevitable question, no I don't think that the BOJ will raise and I think that future data releases will solidify this call; for instance, I am not at all looking for something positive in Monday's release of the Tankan survey of business sentiment. Lastly and before I close up shop for good let me suggest address some general issues and quibbles I have. First off let me try to wave off the obvious. In this way I am fully aware that my analysis presented above could be seen as a deliberate attempt to talk down what in fact is good news on the Japanese economy. However, such accusations would be a mistake. What I do want to emphasise though is the need to look at the data that is actually in front of us and then to apply sound analysis based on whatever theoretical framework we have to work with. Now, this latter part is of course important and I realize that not all share my view of things which is of course fine. But at the end of the day we should all be interested in progressing with empirical vigour which is what I have attempted to do above.


1) Retail Sales

METI have just released the latest retail sales data. The yen value of both retail sales and sales at large stores actually fell from July, although total retail sales did manage to eke out a small 0.5% increase year on year, which was notable since in 9 of the previous 10 months they have actually been down even year on year.

2) Industrial Output

Industrial output was certainly up in Japan in August.

Japan's industrial output surged at the fastest pace in almost four years....Production rose 3.4 percent from July to a record, the Ministry of Economy, Trade and Industry said in Tokyo today.

3) Employment

Well, as reported in the Financial Times today, Japanese unemployment crept up slightly last month:

Japan’s jobless rate rose for the first time in 11 months as more people sought work, underlining concerns about the slow pace at which economic growth has translated into higher wages.

The unemployment rate rose 0.2 point to 3.8 per cent in August, while the job to job-seekers ratio deteriorated slightly from 1.07 to 1.06. The unemployment rate for women rose from 3.3 per cent to 3.7 per cent, according to official figures released on Friday.

Here's the monthly chart:

Also the number of persons employed dropped back slightly. As can be seen from the chart this seems to have peaked in May.

A much fuller analysis of the recent dynamics of the Japanese labour market can be found in this post.