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 Euromoney Skew Blog

News from the banking
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Summers or Yellen? – BCA Research

| Posted by Anonymous

Early results of BCA Research's Daily Insights poll “Who will be the next Fed Chairman?” show that only a small minority of respondents believe that who becomes the next Chairman is irrevelant to financial markets. Furthermore, according to the poll, it is still a tight race between Summers and Yellen. [More]


Indeed, analysts have been rushing out estimates of how much tighter monetary policy will be, down to the second decimal place, if Larry Summers is appointed as Fed Chairman. We think the scaremongering is way overdone.

A careful read of Summers’ speeches and interviews highlights that he is far from a hawk. Yes, he is concerned about structural unemployment, but only in the same way that Chairman Bernanke and Janet Yellen are concerned – a lack of demand today threatens long-term economic performance. If demand growth stays too weak for too long, it damages the long-term growth prospects by reducing capital spending and causing higher structural unemployment as skills erode in the labor market.

This view suggests that if appointed, he would err on the side of more stimulus, not less. In Summers view, policy should by extremely stimulative now in order to boost demand and avoid the potential long-term problems.

Bottom Line: Those analysts factoring in significantly tighter policy under Summers than under Yellen are off the mark. Still, Summers’ appointment would keep volatility elevated until he is able to challenge market perceptions and provide visibility on his policy bias once he is on the FOMC.

This post was originally published by the BCA Research blog.

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US payroll report: Not a 'tapering game-changer' – BCA Research

| Posted by Anonymous

US payrolls increased by 169,000 in August, although downward revisions to previous months brings the three-month moving average down to a disappointing 148,000 per month. Still, BCA Research doubts this data will meaningfully sway the Fed’s thinking. [More]



The payroll numbers are slightly disappointing, but other forward looking data have been much more upbeat (e.g. ISM manufacturing and non-manufacturing surveys). On balance, we think the overall picture painted by recent data points to an improving economy: the payroll report does not provide a sufficient hurdle to modest Fed tapering.

Our base case remains that the Fed will announce modest tapering at its next meeting in September, but will combine this decision with a dovish tweak to its forward guidance. One favored possibility is to lower the unemployment rate threshold.

The August drop in the unemployment rate to 7.3% was due to a decline in the labor force (the denominator) rather than a strong increase in hiring. Meanwhile, the labor force participation rate fell to 63.2%, a new post-recession low. This once again underscores that the unemployment rate misses a lot of under-employment, which has been particularly high this cycle.

At this point in the recovery, labor force participation typically rises as improved job prospects lure previously discouraged workers back into the job market. This has not happened, as evidenced by the still very high rate of U-6 unemployment (which includes marginally attached and ‘underemployed’ workers).

The bottom line is that our base case remains that the pace of U.S. recovery should gather momentum in the latter half of the year. Today’s payroll data is unlikely to be a game-changer in the Fed’s decision to taper, but underscores the possibility of a lower unemployment rate threshold for rate hikes.

This post was originally published by the BCA Research blog.

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Oil risks to the upside – BCA Research

| Posted by Anonymous

BCA Research's base case scenario for the rest of 2013 is for Brent to trade in the $105-115 range, but the risks are strongly skewed to the upside. [More]



Brent should continue to find a floor around $100 over the next 6 to 9 months, despite potential air pockets in demand and stale speculative long positions. OPEC will defend its $100 floor, and conserve spare production capacity, due to mounting geopolitical risks in the Middle East.

Risks to oil prices remain strongly skewed to the upside for the rest of 2013. Middle East tensions have removed significant spare capacity, at a time when the market is seasonally tight. Hence, any further supply disruption would be damaging.

Another upside risk is the potential “product-pull” on crude prices. Strong diesel demand may already be challenging U.S. refinery capacity. U.S. distillate production is at its highest level in absolute terms and relative to gasoline. High distillate crack spreads motivate refiners to bid up oil grades with the highest distillate output. As a result, crude prices get pulled up.

The U.S. consumer will not feel the pinch until oil prices are much higher, because gasoline cracks are likely to absorb most of the increase in crude. This would support oil demand despite higher prices. This dynamic could push crude prices well above the high end of our $105-115 expected range over the next three months.

All in all, our commodity strategists believe that oil prices are likely to be flat to higher over the next 6 to 9 months.

This post was originally published by the BCA Research blog.

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Are rapidly rising yields a potential US equity roadblock? – BCA Research

| Posted by Anonymous

The level of yields is not yet economically-damaging, but BCA Research's US equity team argues that the speed of the advance has reached the point where investors should expect equity volatility. [More]



The speed of the yield jump is unnerving for stock bulls. Bond yields are rising much faster than profit growth. The broad market has run into trouble whenever the growth in yields has surpassed the growth in earnings. More serious equity pullbacks have occurred when this differential is negative 10% or lower, as is currently the case.

This scenario has historically been associated with too rapid an increase in inflation expectations, which spells valuation and monetary trouble ahead. The current signal from this indicator is negative, as the differential is at its widest level in more than 20 years.

However, it should be noted that inflation expectations are not problematic at the moment, and the very low starting point in yields reduces the indicator’s efficacy. Still, this gauge has a reliable track record, underscoring that capital preservation should remain of paramount concern.

Bottom Line: Our U.S. Equity Strategy team is retaining a tactically cautious view of the broad market, and continues to refrain from putting new cash to work.

This post was originally published by the BCA Research blog.
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Tapering and the potential impact on credit spreads – BCA Research

| Posted by Anonymous

According to BCA Research's US Bond Strategy service, there could be some modest disruption in the performance of risk assets as the Fed pares back its asset purchases. [More]

One key question about Fed policy is whether quantitative easing works through the portfolio balance channel (i.e. the stock view) or whether it is the pace of purchases that matter (the flow view). Another is whether asset purchases matter at all or whether it is simply the implicit guidance associated with quantitative easing that has served to ease monetary conditions.

At this point, it is too early to confirm which mechanism is at work, but we can confirm that the expansion of the Fed’s balance sheet did coincide with abnormal depression of the term premium deep into negative territory. The compressed term premium has helped to support the market for spread product.




The above table shows the returns for various assets during the three episodes of quantitative easing to date. In almost every case, asset returns were greater in weeks when the Fed was buying more than the median amount of securities, and lower when it was buying less.

These results suggest that some modest disruption in credit spreads is possible as the Fed embarks on tapering its asset purchase program. Reduced market liquidity could exacerbate volatility in the near run. Nevertheless, corporate fundamentals remain strong and accommodative monetary policy means that the search for yield will remain intact for another couple of years at least.

This post was originally published by the BCA Research blog.
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Buy US bank stocks, short Canadian banks – BCA Research

| Posted by Anonymous

BCA Research's Global Investment Strategy service recommends going long US financials while shorting their Canadian peers: housing dynamics are completely out of sync between the two markets. [More]

The US residential market is recovering briskly from very depressed levels while the Canadian housing market looks increasingly vulnerable, with record amounts of household sector debt.

It should be noted that Canadian household debt-to-income ratio has already surpassed US levels reached back in 2007, when America’s housing market peaked out.

The chart above shows the relative price trends between the two housing markets along with the relative performance of American banks versus Canadian ones. It appears that the secular downturn in American banks has ended. Canadian banks are set to underperform, especially if the Canadian housing weakens.

This post was originally published by the BCA Research blog.

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China: More tightening on local government debt? – BCA Research

| Posted by Anonymous

BCA Research's China Investment Service argues that any move towards gaining clarity on the Chinese local government debt situation is a market friendly development. [More]

Last Friday, the Chinese central government ordered an immediate auditing of the country’s murky local government debt situation, stoking fears that local government debt levels are getting out of control and that the government is preparing a fresh round of crackdowns on borrowing by localities. However, our China strategists believe that prevailing fears on the local debt front are misplaced.

Beijing’s focus is to prevent a further rapid increase in local government debt rather than to induce a sharp contraction that could put the economy and the banking sector at risk.

The debt issues of local governments and financing vehicles have been thoroughly discussed by investors, analysts, rating agencies and market regulators both inside and outside China. A wide range of numbers have been suggested, ranging from the previous government’s audit of about RMB 11 trillion to as high as RMB 25 trillion, or close to 50% of Chinese GDP. It is unlikely that the official audited numbers will fall beyond these ballpark estimates.

Local government borrowings are ultimately China’s fiscal liability. Even under the most aggressive assumptions discussed in the marketplace, China’s total gross public sector debt, including local and central governments, is still not excessively high compared with that of most countries. Moreover, the Chinese government also owns vast amount of assets. Therefore, the net debt situation is easily manageable, especially considering the country’s very high domestic savings rate.

Finally, the fact that the Chinese government has not come up with concrete and credible information on the level of public sector debt has been far more damaging, as it has left the door wide open for guesstimates and rumors, which in turn has weighed heavily on investor confidence. Therefore, revealing the real situation is an essential first step in addressing one of the major macro question marks on China’s economic future.

This post was originally published by the BCA Research blog.

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Euro area: No longer the ugliest of them all – BCA Research

| Posted by Anonymous

On several key measures – government finances, competitiveness and banking solvency – the euro area is no longer winning the world’s 'ugly contest', according to BCA Research. [More]


  • Given that Europe had the world’s ugliest structural deficits in 2009, the biggest fiscal drags through 2009-12 were obviously concentrated in the euro area. The good news is that through 2012-15, the world’s largest fiscal drags will be outside the euro area. Moreover, the latest credit data from the ECB confirms that euro area fiscal drag is easing. The government credit impulse is improving, which should help to lift the euro area economy out of its “endless recession”.
  • The competitiveness of many euro area economies also looked ugly at the peak of the debt bubble. But after the last few years of austerity, that picture has changed. Most euro area economies no longer have a big competitiveness problem against their global trading partners.
  • In terms of banking undercapitalization the euro area may no longer be winning the ugly contest either. Britain’s second-largest bank, Barclays, is scrambling to boost its capital to at least 3% of assets – as demanded by the UK banking regulator. This highlights that undercapitalization is not just a euro area problem. In fact, after several years of gradually raising equity, banks’ average tangible common equity to total assets ratios in the distressed euro area now appear healthier than the ratios in the UK or Sweden.

All of this supports our view that, given their much more attractive long-term valuations, euro area equities remain well placed to outperform other markets in relative terms.

This post was originally published by the BCA Research blog.

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Is a Grexit possible before the German elections? – BCA Research

| Posted by Anonymous

The probability of Grexit has increased due to several factors, according to BCA Research: [More]

  1. Austerity measures are being implemented, particularly the placement of 25,000 public sector workers into ‘reserve’ (from where they can be fired after 8 months)
  2. The governing centrist coalition has had its majority in the 300-seat parliament reduced from 167 to 155 due to a junior coalition member quitting over austerity measures
  3. Greece has achieved primary surplus, which means that the austerity is enacted purely to pay the official sector cost of interest on loans. However, the probability was low to begin with.

While we do believe that the three factors above have increased it, we are talking a jump from somewhere in the single digits to 10-15%. This is because:

  • Euro area exit is unpopular in Greece. Even the far-left SYRIZA has caught on that Greek voters fear uncertainty and therefore do not want to risk Grexit.
  • Post-German election, an OSI (Official Sector Involvement) is likely, with further cuts in interest rate payments and extension of debt maturity at the very least
  • Greeks have an upper hand in negotiations due to reaching primary surplus, so they will likely eventually receive OSI

An OSI is not an option, and cannot be discussed, in the run-up to the German elections. So it won’t be. However, it is the likely outcome eventually of another Greek showdown.

The German election is two months away, including August which is usually completely dead in terms of news flow out of Europe. As such, it is highly unlikely that Greece will come up before the election. Particularly not after they already received the funding from the official sector and have passed the necessary legislation.

As they fail to deal with implementation of austerity, and further disappointment with privatization, Greece should flare up again as an issue in late-2013. Post-German election, however, Merkel will have the necessary political carpet to shove it under the proverbial carpet.

This post was originally published by the BCA Research blog.

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US stocks: What now? – BCA Research

| Posted by Anonymous

The US stock market is becoming fully valued, with the market trading at 14.5 times forward earnings, according to BCA Research. [More]


True, corporate earnings are still good and could get even better in the months ahead, especially if global economic conditions improve and the dollar’s appreciation takes a pause.

But over the longer run, corporate profit growth will inevitably gravitate toward nominal GDP growth, which should be around 4-5% per annum.

Expected returns in US common stocks should be around 6% (with a dividend yield of 2%). Anything above this expected return should be considered excessive, and would rely on continued multiples expansion.

Such expansion remains possible, but will depend on the interaction between the US economy and Federal Reserve policy. Any increase in interest rate expectations may not be conducive for a continued upward re-rating of equity multiples.

Bottom Line: The risk-reward trade-off in US stocks is less appealing now that equity prices are in the fair-value range. We are comfortable with our neutral stance for now.

This post was originally published by the BCA Research blog.

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US homebuilders: Another summer pop! – BCA Research

| Posted by Anonymous

US homebuilders are starting to look downright giddy, according to BCA Research. The National Association of Homebuilders survey of builder confidence popped to its highest level since January, 2006. [More]



According to the survey: “Builders are seeing more motivated buyers coming through their doors as the inventory of existing homes for sale continues to tighten."

Indeed, the household formation rate has returned to its historical average, after being severely depressed during the Great Recession. Foreclosures have significantly subsided, which removes a significant headwind. Importantly, the recent rise in mortgage rates has so far not been problematic for builders – all four regions reported increased activity.

Bottom line: residential construction will continue to make a solid contribution to GDP in 2013.

This post was originally published by the BCA Research blog.

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Houston, we have a (communication) problem – BCA Research

| Posted by Anonymous

If the FOMC is trying to improve its communication with clear messages, the June minutes fell far short of the mark, according to BCA Research. [More]

It was reported in the Summary of Economic Projections (SEP) section of the Minutes that about half of policymakers want to wind down QE altogether by the end of this year, even faster than what the Chairman suggested in his post-meeting Q&A session in June. Policymakers are concerned about the costs associated with quantitative easing, and wish to rely almost exclusively on forward rate guidance as the main policy tool.

Given this urgency, it thus seems odd that the costs of QE were only briefly mentioned in the summary of the policy discussion. Indeed, most of the discussion was centered on why not to taper; inflation is well below target and policymakers are still not happy with the pace of payroll growth. Indeed, “many” policymakers indicated that they would only be in favor of dialing back QE if there is “further improvement in the outlook for the labor market”.

Is there really enough time to make a judgment on the labor market, and then to fully taper QE by the end of the year? The plan doesn’t seem to fit together very well.

Cutting through the messy communications, we interpret the statement in the SEP as signaling that tapering will be announced at the September meeting, unless the economic data suddenly nose-dives in the coming weeks. Inflation does not appear to be a factor in the QE decision.

At the same time, policymakers must be concerned about the surge in borrowing rates since the June meeting. There is a good chance that the FOMC will combine the tapering announcement with a reduction on the threshold unemployment rate used in the forward rate guidance, perhaps to 6% from 6.5% currently. This would underscore that tapering is not tightening and push back expectations for the fed funds rate lift-off date.


The upshot is that the Treasury selloff is probably over for now, and yields will drift lower over the summer as oversold conditions are unwound. Longer-term, the outlook for Treasurys remains negative since we expect real GDP growth to accelerate to an above trend pace late this year and into 2014. 

This post was originally published by the BCA Research blog.

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Is Abenomics working? – BCA Research

| Posted by Anonymous

There are some signs that Abenomics is beginning to bear fruit, according to BCA Research. [More]



Although many have cast doubts over Shinzo Abe’s reform plan, there are emerging signs that aggressive monetary reflation is having a positive impact on the Japanese economy. Money and loan growth has reaccelerated, consumer confidence has risen and the Tankan business survey has also spiked.

Most importantly, financial markets seem to believe that the authorities will achieve their inflation target. For the first time in many years, inflation expectations in Japan have risen above 1%. In short, the Bank of Japan (BoJ) so far appears able to manage a revival in consumer and business confidence via a combination of large-scale QE program and a sharp yen devaluation. We see no reason why these positive trends will come to an abrupt end, so long as the BoJ maintains its policy (the BoJ meets later this week – stay tuned).

This post was originally published by the BCA Research blog.

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Japan: On the path to debt monetization – BCA Research

| Posted by Anonymous

According to BCA Research's Bank Credit Analyst service, current Japanese policies will be insufficient to finally break deflation’s grip. The good news is that policymakers are not without options. [More]

The government will have to postpone the VAT hike scheduled for next year and the Bank of Japan (BoJ) will have to implement one or more of the following policies to end deflation once-and-for-all: adopt an explicit nominal income targeting regime, buy foreign bonds, or monetize government debt.

The government has already implemented a type of nominal GDP growth target of 4%, given that it hopes to achieve 2% real growth and 2% inflation in three years. Policymakers could make this target more explicit by promising to keep interest rates at zero and to buy government bonds at a certain pace until private sector forecasts for the level of nominal GDP converge on the BoJ’s target path.

Nominal GDP targeting would be an obvious next step if real yields began to rise and inflation expectations trend lower on a sustained basis, which would be an indication that current policies are failing. Beyond that, buying foreign bonds and debt monetization are possibilities, although both would be politically controversial.

All three policy options would drive up inflation expectations and depress real bond yields across the curve. Debt monetization would be the most potent in terms of boosting inflation expectations, depending on the size of the program. Indeed, monetizing all of the debt held by the central bank could even spark fears of hyper-inflation, although the authorities are unlikely to take it that far.

Buying foreign bonds would lift inflation expectations via a weaker yen and rising import prices. The BoJ already holds foreign assets, so the policy would not be unprecedented. However, Japan’s trading partners might howl in protest. Another problem is that the yen would have to fall continually to keep imported inflation at a high level. The BoJ would also have to maintain aggressive purchases of JGBs to avoid nominal yields from rising too quickly.

That said, these policy options would only be considered after nominal income targeting is attempted, and thus are not near-term concerns for investors.

This post was originally published by the BCA Research blog.

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Australia: A fading star? – BCA Research

| Posted by Anonymous

BCA Research's Global Investment Strategy service takes a rather bearish view on the Aussie economy and financial markets. [More]


Australian shares ended their spectacular 10-year bull market relative to the global benchmark in 2008. They have since lagged the global average by about 25% over the past four years. The yield curve inverted and has remained flat as long-term interest rates have dropped, even though the RBA has been cutting short rates.

One of the headwinds that explain why Australia’s economic and financial market fortunes have taken a turn for the worse is the weakness in commodity prices. Historically, Australia has always been a commodity play, but its dependence on commodity exports has increased massively since the beginning of the last decade. The share of commodity exports has risen from less than 45% of total exports in 1996 to more than 72% in 2011-12.

It is worth noting that the increase in Australia’s terms of trade during the last decade was both one of the largest and longest in over 100 years. According to the Australian Treasury’s 2012 report, the improvement in the terms of trade contributed to about half of the overall annual increase in Australia’s real gross national income over the last decade. For example, mining sector employment has tripled, investment has increased by about 600% since the early 2000s and was responsible for 2.2% of the 3.6% total real GDP growth in 2012.

The problem is that mining investment is now projected to decelerate sharply over the next five years. The value of committed mining investment projects peaked at A$270 billion (18% of GDP) in 2012 and the government is projecting that it will likely drop to A$30 billion (less than 2% of GDP) by 2018. This staggering decline, if it were to play out as expected by the government, would be a massive structural headwind for Australia.

In addition, despite the recent drop in the Aussie dollar, its real effective exchange rate is hovering around its multi-decade highs, putting enormous pressure on Australian non-mining businesses along with the overall economy.

The Aussie stock market will continue to lag until the Aussie dollar weakens substantially. 


Historically, adjustments in the Australian dollar have been a key factor in coping with terms-of-trade shocks and fending off either inflationary or deflationary pressures. But since the end of 2011, when commodity prices began to weaken, the AUD has acted less like a shock absorber.

Although both metals prices and Chinese real GDP growth argue for a much weaker Australian dollar, the AUD has remained strong relative to what the terms of trade would suggest.  One key reason for the unusually strong AUD is because of the high interest-rate spread between Australia and the rest of the world.

As well, during the European debt crisis, Australia attracted large inflows of capital, seeking safe-haven assets. Australia is considered a fiscally-conservative economy, with a government debt-to-GDP ratio among the lowest in the developed world.

A significant fall in the AUD from its current overvalued levels would help revive a slowing Australian economy, but that would require a substantial reduction in domestic interest rates. This is already at play, but the rest of the industrialized world is running a monetary policy that is still much looser than the RBA’s.

The relative performance of Australian equities depends on whether the RBA eases policy more aggressively to get itself ahead of the curve. We think that more currency depreciation and RBA easing are needed for Australian stocks to cease underperforming. The almost-inverted yield curve suggests that RBA policy is still too tight.

This post was originally published by the BCA Research blog.

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Protests in Brazil: Policies have consequences – BCA Research

| Posted by Anonymous

Brazilians are coming to terms with a new economic reality: the commodity fuelled growth bonanza has run its course and living standards are failing to keep up with the government’s rhetoric on Brazil’s growth miracle. This downward adjustment in expectations is causing a major political malaise, according to BCA Research. [More]



Protesters are lining the streets of Brazil’s major cities, demanding everything from lower bus fares and less corruption to a new political system.

Amidst anemic growth, Brazil’s policymakers have misdiagnosed the economy’s supply side bottlenecks and lack of structural reform and have instead opted for a sustained demand-side push. This misdiagnosis has meant that massive fiscal and monetary stimulus has failed to lift Brazil’s growth by much.

Now, as inflation is rising, room for further policy stimulus is limited. Additional fiscal stimulus will only lead to more inflation and cause the currency to drop significantly further. In turn, interest rates will shoot up even more.

As such, the current economic and political backdrop is bearish for Brazil’s financial markets, including equities, the real, domestic bonds and sovereign and corporate credit.

Our Emerging Markets Strategy service continues to recommend shorting the real versus the US dollar, and underweighting Brazilian sovereign credit and equities within EM credit and equity portfolios. 

This post was originally published by the BCA Research blog.

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Australian dollar: oversold – BCA Research

| Posted by Anonymous

Within the G10 currencies, the position adjustment in the Australian dollar has been the swiftest, and leaves the currency with decent upside, according to BCA Research. [More]


Over the past few weeks, speculators have gone from a large long position in the Aussie to a near record short position. Our FX strategists maintain that the primary trend for AUD/USD is up.

Among the developed economies, interest rates are still highest in Australia and the RBA is likely to keep rates steady for the foreseeable future. Investors will be forced to play the carry trade to the advantage of the Aussie dollar.

Currently, momentum and positioning indicators are bombed out, suggesting a good entry point for long positions in AUD/USD. A more sustainable upleg in the Aussie should unfold once the money markets stop bringing forward the timing of the Fed’s exit and/or Chinese growth surprises to the upside.

This post was originally published by the BCA Research blog.

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Japanese Nikkei: Hold on! – BCA Research

| Posted by Anonymous

Despite the massive correction, the multi-year outlook for Japanese equities is positive, provided policymakers can retain credibility, according to BCA Research. [More]

We have written in previous research that the massive gains made in the Nikkei earlier this year would be subject to corrections – investors would be in for a bumpy ride. Indeed, of the 80% gains made since the bottom in November 2012, the Nikkei has given back almost half (46%). But even after the brutal selloff, overbought conditions are still not unwound.



We still think the secular bullish case for Japanese equities is intact, but the key will be for Japanese policymakers to retain credibility. How? Since the BoJ has committed themselves to an inflation target of 2%, policymakers will likely have to be prepared to see inflation expectations overshoot and not back off the pedal. In this way, investors will gain conviction that entrenched inflation will be delivered. Note that this could be a multi-year process that will not occur in a straight line.

For now, it is unrealistic to expect more from monetary policy, but the Japanese government could show some leniency on the fiscal front. The OECD estimates that the fiscal drag will be 2.6% of GDP in 2014. Postponing the increase in the VAT tax – scheduled for next year – would be one way to reduce the drag and would send a strong signal to financial markets about the government’s priorities. 

This post was originally published by the BCA Research blog.

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