J.P. Morgan says Japan will need reform and not just quantitative easing

8th April 2013

J.P. Morgan Asset Management says that the Bank of Japan’s bold quantitative move last week may help financials but may have a less dramatic impact on the broader economy.

In a note, J.P. Morgan global strategist Dan Morris writes: “The Bank of Japan’s decision to double the monetary base through government bond purchases surprised most market observers and sent the Topix to a 2.7 per cent gain for the day. The bulk of the index’s return came from the financial sector, namely banks, real estate developers and REITs. However beneficial quantitative easing may be for the financial sector, the impact on the broader economy may not be so dramatic.”

It also suggests that the goal of doubling the monetary base is not as ambitious as it first appears. It also notes that the Bank of Japan was a pioneer in quantitative easing. “A decade ago it launched its first round of unorthodox monetary stimulus, which increased the monetary base by 1.7 times. The three rounds of QE from the US Federal Reserve have been much larger, with the monetary base increasing by 3.6 times since 2007 for the UK it is even greater still at nearly five times.

“During Japan’s first attempt at QE from 2000 to 2005, the Japanese stock market rose 24 per cent compared to a 6 per cent drop in the MSCI Kokusai index (World ex-Japan).  But Japanese equities moved roughly in line with the rest of the world for almost the whole period. It was only following the LDP’s landslide victory in 2005 led by Junichiro Koizumi on the back of promises for reform that it outperformed. The currency meanwhile initially weakened against the dollar from 2000 but then strengthened until the LDP election. This pattern highlights how it is not more aggressive monetary policy but economic reform that  is necessary to restore the Japanese economy to health. The initial euphoria following the election in 2005 was eventually replaced by disappointment and a resumption of Japanese equity market underperformance. Avoiding a repeat is the biggest challenge facing the Japanese government today.”

Morris says worries about inflation may be overdone and in Japan it is a goal rather than a concern. “Experience in the US and UK suggests these worries may be overdone. The UK already had an inflation problem before the crisis began due to structural problems in the economy. One reason quantitative easing has not exacerbated inflationary pressures either in the UK or the US is that, absent strong economic growth, there is little opportunity for the cash to create additional inflation. Another way of saying this is that the money simply sits as excess bank reserves instead of circulating through the economy; that is, the velocity of money falls. This is what has happened in the US over the last several years. The jump in the supply of money has been neatly matched by a fall in the speed at which it’s moved around the economy, keeping inflation in check.”

“It is nonetheless likely that once stronger economic growth returns, the money would add to inflation. At that point we would expect the central banks to begin removing the excess cash, however, so that inflation ultimately does not materialise.”

Morris goes on to consider US employment below.

“Markets reacted poorly to the disappointing March jobs figures from the US on Friday. This was to some degree justified as the increase in private payrolls was half what forecasters had expected. The data needs to be kept in context, however. Payroll growth has been better than expected for the last six months and the previous month’s were revised upwards. Moreover, the unemployment rate continues to fall, from 7.7 per cent to 7.6 per cent, driven mostly by a decline in how many people are without jobs, not by changes in the participation rate. In fact, the number of unemployed has dropped below 12 million for the first time since 2008.

“By the summer or autumn of next year, at the current pace, the unemployment rate should reach 6.5 per cent, the target the Fed has set to indicate the labour market is strong enough for them to end their own QE programme.  The ongoing stimulus from the Fed will be a positive backdrop for the economy, but QE is no more a panacea for the US than it is for Japan. The American economy is recovering on its own and it is for this reason we expect US equities to continue to post positive returns, if not quite so strong as what the market was able to achieve in the first quarter.”


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