What could destabilise the Japanese economic recovery?
Article | 05 May 2017
While there are signs of stability in Japan’s economy, should we be mindful of an unusually unclear outlook?
At the moment, the Japanese economy is recovering mainly because the global economy has improved: the Chinese stimulus is working for the time being; the yen is weaker, which gives a boost to Japanese export performance and the US economy remains relatively robust. Meanwhile at home, policies from the Central Bank and the Abe Government are aligned in supporting domestic growth. Looking further ahead, we find that the outlook is unusually unclear.
The Japanese domestic economy tends to follow the trend in the global economy. As such, with a relatively stable outlook currently, many key economic indicators have been moving higher, including industrial production and exports. There has also been a modest improvement in consumer activity, but one which has so far failed to gain real traction. The labour market is tight but it is not causing wages to rise by more than 1%. Expensive baby boomers are being replaced by cheaper younger workers, and the ratio of temporary workers remains high. We expect this will probably remain a drag on the outlook for wages, and thereby limit growth in the domestic economy. Also, the combination of a weaker yen and higher commodity prices is creating some inflationary pressures. However, this is ‘bad inflation’ as higher prices will simply have a negative impact on consumers’ disposable income, unless the outlook for wages improves.
President Trump’s campaign promise to “Make America Great Again” could result in the introduction of protectionist trade policies. This would be negative for any countries enjoying favourable terms of trade with the US, and particularly bad for countries very dependent on export performance, like Japan. We think this is unlikely to be meaningful in practice as Japan’s manufacturers have similar supply chains to their American counterparts; but it remains a risk, in our view. Furthermore, if President Trump’s ambition to boost America’s growth by cutting taxes and boosting spending is achieved, it may mean higher interest rates sooner in the US. This could be negative for activity, and equity markets, in the event that President Trump’s measures are not successful in boosting economic growth. This risk could be particularly important for Japan.
Meanwhile, the Bank of Japan has moderated the pace of easing measures. So far, this is not causing the yen to strengthen versus the US dollar, partly due to the dollar benefiting from expectations of higher US interest rates. However, later this year we could potentially see the yen correct upwards, once we have clarity on just how much the US is going to tighten monetary policy.
In light of the above positive and negative factors, the Invesco Perpetual Japan Fund has a largely balanced approach, between yen-sensitive cyclicals (held for the shorter term improvement in economic momentum and profits) and domestic staples, which we see as more interesting in the medium term. As we mentioned at the beginning, we think the economic outlook at the current time is unusually unclear. The more the cyclicals in our fund outperform, the more we are inclined to increase domestic and defensive exposure to seek to mitigate the potential risks that we could face as the year progresses.
The Invesco Perpetual Japan Fund may use derivatives (complex instruments) in an attempt to reduce the overall risk of its investments, reduce the costs of investing and/or generate additional capital or income, although this may not be achieved. The use of such complex instruments may result in greater fluctuations of the value of the fund. The Manager, however, will ensure that the use of derivatives within the fund does not materially alter the overall risk profile of the fund.
Where Paul Chesson has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco Perpetual investment professionals.
For the most up to date information on our funds, please refer to the relevant fund and share class-specific Key Investor Information Documents, the Supplementary Information Document, the ICVC ISA Terms and Conditions, the Annual or Interim Short Reports and the Prospectus, which are available from the Literature section.