Japan Data and Flows

In recent weeks several investment houses and observers have suggested the attractiveness of Japanese shares. It is difficult as is often the case that what came first the upgraded assessments or the flows. The fact of the matter is, drawing from MOF data, foreign investors have been net buyers of Japanese shares for nine consecutive weeks through last week. Moreover, the buying in January, through then was more than 60% greater than the whole of December (based on weekly data).

As counter-intuitive as it may seem, foreign purchases of Japanese shares is not a reflection of a bullish yen view. Given that foreign exchange component is the key to total return on fixed income investment, a fund managers bullish the yen is more likely to be Japanese bonds than equity. Many observers attributed the Nikkei's relative performance during the last nine months of 2009 to the relative strength of the yen. The yen, it will be recalled, weakened around 10% from late Nov through early Jan and the Japanese stock market tended to out perform the other G7 markets.

Japan reports a full sales of economic data before the end of the week. Labor market conditions are expected to have deteriorated in December with the unemployment rate ticking up to 5.3%. The recent peak was 5.7% in July 09 and with the job-to-applicant ratio remaining anemic, it would not be surprising to see the unemployment rate trend higher in the coming months. The weakness of the labor market in turn constrains consumption, which we saw earlier today with the unexpectedly large (-1.2% vs consensus of -0.2%) drop in Dec retail sales. That report in turn points to downside risks to the Dec household spending report due out at the same time. That said, Japanese households have tapped into savings to sustain consumption.

Japan is the only major industrialized country that continues to experience deflationary forces. That message will be driven home with the Jan Tokyo CPI and national figures for Dec. It does not matter much if the deflationary forces have ebbed marginally. The take away point is that deflation persists and may still elicit further policy response. The BOJ will remain under pressure to extend QE: extend tenor and/or amount of the JPY10 trillion 3-month funding facility and/or increase direct purchases of government bonds. Minutes from the Dec BOJ meeting will also be released and this might shed some light on the BOJ's thinking about the scope for additional measures.

If there is a less negative piece of news from Japan, it could come from the industrial production figures. Anecdotal data suggests industrial output saw a healthy rise in December. The increased output appears aimed more for foreign demand--exports--than domestic consumption. There may be an inventory component as well. Industrial output has been recovering through the current fiscal year that began 1 April 2009. What is noteworthy about the expected rise in Dec industrial output is that it is likely to be the first positive year-over-year print since Sept 2008.

Housing starts will also be reported. The nearly 19% year-over-year decline expected for December is likely to be the smallest decline of the year. In contrast, US housing starts in 2009 were around 40% lower than 2008.

The yen was the weakest of the major currencies in Dec, losing a little more than 7% against the dollar. Thus far in January it has been the strongest currency, appreciating about 3.25% against the dollar. The only other G10 currency to have gained against the dollar is the Australian dollar and its 0.16% gain is really a round error. Resistance now for the dollar is seen in the JPY in the JPY90.50 area. The near-term risk on the downside extends toward JPY88.25. An advance through the JPY90.50 could spur a move back toward JPY92.00, while a break of JPY88.25 could quickly see JPY87.00.