A quick summary of the grim top-down picture unfolding

This week we touch upon on number of developments that keep us awake at night and go beyond just Japan. But first, we want to quickly focus on BOJ’s latest policy meeting which left its ultra loose policy stance unchanged with no further tweaks to its yield curve control, nor expressing much concerns about the crumbling value of the yen. 

We have argued that these policy errors are effectively destroying the nation’s purchasing power and inviting more imported inflation, especially during when energy prices are on the rise again. We were alarmed to learn that high net-worth Japanese have been buying gold to protect their assets from risk of more depreciation of their currency, perhaps highlighting the mood among domestic investors. 

Japan’s central bank conceded that its near-term inflation rate forecasts have been too modest but insisted that that the rate of growth will decelerate in the coming months, but only to pick up again. Interestingly, this caveat about rates picking up again was the only new and we think important narrative the bank has introduced last week. Come what may, we think yen is held hostage by the market here and policy makers are coming under more pressure to pivot as currency intervention alone will simply not work. 

Moving on, global markets seem to have been taken back by the continued hawkish tone of the Fed which has stayed its own course in predicting that rates will stay ‘higher for longer’. After months of disbelieving the US central bank, investors seem to be finally coming round to such an outcome leading to a broad sell-off of growth stocks for much of last week. 

With economic slowdown both in US and particularly in Europe becoming more notable, we have retained our generally negative stance regarding Japan’s manufacturing exporters despite the benefits of the weaker currency which has inflated overseas earnings and has masked falling sales volumes. Indeed, had it not been for the auto sector which has benefited from auto chip supply issues disappearing and allowing output to rise, a near term positive that will likely fade by next year, Japan’s exports would have been weaker still. 

Another worrying development is rebounding input costs as higher oil prices are starting to hurt. With Opec and Russia agreeing to keep supplies tight, price of diesel is surging, adding more misery to sectors such as shipping and trucking which have already been hit hard by falling volumes. Russia’s latest decision to ban diesel exports was presumably aimed at making life tougher still. 

Indeed, geopolitical risks clearly remain elevated with EU’s latest probe into Chinese EV makers which are winning share in the region, looking to make matters worse. With China threatening to retaliate, German luxury car makers look particularly exposed. Moreover, reports suggesting that China has asked its EV makers to dramatically raise their domestic content with home-made components brings its own disruption risks that could also hurt key Japanese suppliers.

But nowhere is this geopolitical decoupling more apparent than in semiconductors where we think export restrictions of manufacturing tools and materials to China will likely get a lot tougher. With Huawei managing to develop its own 5G mobile chip, a feat that even Apple has yet to achieve, while SMIC having successfully shrunk its chip geometries nearing cutting-edge nodes using older tools, there seems to be a growing consensus among US lawmakers that export restrictions to China have not gone far enough. 

The growing industrial strikes are yet another unknown to grapple with and seems to be ushering a new era of workers demanding much better pay after what they believe are years of unfair profit sharing. United Auto Workers are demanding a hefty 36% pay increase (among other things) from all three big car makers while SAG Aftra strike in Hollywood which led to voice actors and script writers walking out back in May, still continues today.

Worth also noting that Ford has just managed to avert a strike in Canada by agreeing to a pay deal with Unifor while Chevron has just settled its pay dispute with an Australian union alliance that have been on strike for the past two weeks threatening to disrupt 7% of global LNG supplies. Given the acute labour shortages on one hand, and pressure to bring production home on the other, unions seem to have a strong hand. All these seem to indicate that higher labour costs are here to stay.