Morning Commentary: Sayonara

Foreign Exchange - Morning Commentary
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Japanese PM Shinzo Abe has announced that he is stepping down to undergo treatment for a chronic illness.  This announcement ends PM Abe’s tenor as the longest serving PM in Japanese history.  Abe has confirmed that he is dealing with ulcerative colitis, a chronic digestive condition that also forced him to step down as PM in 2007. 

Abe is best known for “Abenomics” or a set of unprecedented monetary easing and regulatory reform plans designed to revive the Japanese economy.  Abe will stay in power until the next PM is elected with the LDP, Abe’s political party, expected to choose the new leader in the coming weeks.  An LDP leadership election in September seems likely, but it is still unclear exactly when this will happen. 

After his announcement, the yen strengthened and stocks in Tokyo were down sharply, but a major selloff is not expected.  Abe’s resignation is certainly a dramatic development but few drastic changes are expected from Abe’s successor.  Here’s a look at some key policy points.

Monetary Policy: BOJ Governor Kuroda remains in place.  Abe’s resignation comes due to health issues and not due to a failure of economic policies.  There shouldn’t be any pressure for Kuroda to resign and even less pressure to change monetary policy. 

Fiscal Policy: This factor depends on who the next PM is but policy continuity is likely.  If key allies such as Suga, Kono or Kishida become the next PM then fiscal policy shouldn’t change materially.  If Ishiba is the next PM, then there is the possibility that fiscal policy gets slightly tighter but likely still expansionary.  Overall, the general fiscal policy stance likely continues. 

Japanese Government Bonds: As long as fiscal and monetary policy remain relatively unchanged, the impact on government bonds should be limited.  Keep in mind that short term rates are anchored with a minimal chance of a rate cut or hike.  The dominant factors determining supply and demand of JGBs should not be materially impacted.
  • Jay Powell outlined the Fed’s new approach to inflation and employment yesterday.  The Fed will now attempt to average inflation of 2% which means it will tolerate overshoots to compensate for undershoots (such as the period from which we came.)  The ECB is also undergoing a similar policy review and the Fed’s decision could help ECB President Lagarde push for a similar problem.  In essence, it will be lower for longer for quite a long time. 
  • US personal income and spending both beat market expectations.  PCE deflator and PCE core deflator, two of the Fed’s favored inflation indicators both missed expectations at 0.3% and 0.3% versus expectations for 0.4% and 0.5%, respectively. 
  • Canadian June GDP beat expectations at 6.5% versus consensus for a 5.8% print.
  • The yield curve continues to steepen and is sitting around its widest level in ~2 months after Powell’s announcement on how the Fed will look at inflation.
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