japan_flag_blowing

Does this equation make sense to you? Probably not, but it's what the Japanese are experiencing right now.

They have an aging population, a terrible economic growth profile, and a massive debt load. But now that the Bank of Japan is proceeding with what I'll call Quantitative Easing on steroids, the yen has plunged and investors have pushed the Nikkei 225 Index higher by 68% since mid-November. The Nikkei's 3% gain on Friday pushed the Japanese benchmark to a level not seen since 2008.

Read: Japan still unstable

Quantitative easing won't fix demographic and other structural problems, but it will help weaken the yen to stimulate exports in the near term.

TRADING WEEK AHEAD

Earnings season will slow considerably this week as almost all companies in the United States have reported Q1 results, while Canadian earnings will focus mostly on small to midcap resource plays. But there are still two U.S. Dow heavyweights yet to report: Cisco Systems and Wal-Mart Stores. We'll see those results Wednesday and Thursday, respectively.

Aside from the smaller cap names in Canada, there will be some larger cap companies providing updates, such as Power Corp and Power Financial, along with real estate heavyweights H&R REIT and Boardwalk REIT. While we've seen a lot of discussion about central banks recently, it may die down as no major central banks are expected to meet or make any new announcements over the next five trading days.

The next central bank to make headlines will likely be the Bank of Japan, which won't meet again until May 22. So we may see more focus on economic data next week in the absence of any other news. In Canada, most of the focus will likely be on inflation data, due out next Friday. The report is expected to show that inflation remains contained and is unlikely to influence monetary policy in the near future. In the United States, economists will likely also focus on inflation as we'll see both consumer and producer price indices.

Read: Japan to enter major trade negotiations

We'll also see data on retail sales and housing, which may capture the Street's attention.  Downward pressure on the Yen and other currencies will likely see a continuation of support for the U.S. dollar, which could make commodity price gains tougher to come by. They may also put a cap on Canadian dollar gains seen since the end of April.

QUESTION OF THE WEEK

I hear that Japan has started a "currency war."  What exactly does this mean?

Here's the short answer. If you've ever taken an introductory macroeconomics course, you've likely seen the equation GDP = C + I + G + X.  This means economic activity (GDP) is equal to the sum of Consumption (C) + Investment (I) + Government Spending (G) + Net Exports (X) within a given country or region.

In many countries today consumers are buying less, investment is struggling and government spending is declining. So the only way GDP will increase is if net exports rise.

So how do you grow exports? As Canadians, we know from the 1990s that a weaker currency helps our exporters. But those same exporters will tell you how difficult it is to increase trade when the loonie is essentially at parity with the U.S. dollar. So Japan, which has been struggling economically for a very long time, has decided to dramatically increase its quantitative easing program to either drive down the value of the yen or help drive up the value of foreign currencies.

By making products cheaper, the Japanese government and Bank of Japan hope to see exports, and thus economic growth, appreciate. But net exports are a zero-sum game: one country's imports are another's exports. Therefore, if Japan wants to see its export level rise, other countries will see their export levels fall.

Japan may have triggered a race to the bottom when it comes to currencies, as a number of other countries would love to see their currencies fall to help increase trade. This competition will hurt other countries/regions with relatively stronger currencies and puts a great deal of economic pressure on Europe in particular.

While the Europeans would love to see the euro plunge, it remains relatively unchanged year-to-date and other exporting countries in Asia are not particularly pleased with what Japan is doing.

It could lead to retaliatory action, which may include tariffs and other protectionist measures. Europe gets the short end of the stick since its complexity can limit the effectiveness of monetary policy.

Read: Hedge your bets on Japan

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends.
@Gareth_RGMP
Originally published on Advisor.ca

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