Notes from the Investment Floor: Why’s Japan’s inflation still so low?
Notes from the Investment Floor: Why’s Japan’s inflation still so low?
Dan Carter discusses the macroeconomic dynamics at play in Japan, as the ‘immovable object’ of domestic deflation meets the ‘unstoppable force’ of global inflation.
The global investment story of this year is, in the broadest terms, one of rising inflation and tumbling markets. Yet Japan’s macroeconomic conditions are different from those in the rest of the world. It has seen a creeping rise in inflation to a level of 2.5%, which is high by its own historical standards but compared to the rest of the world (US 8.6%, UK 9.1%, Euro Area 8.6%) is small beer, while its market has fallen by only a few percent in yen terms.
That reference to ‘in yen terms’ is crucial, because any underlying outperformance of the Japanese equity market has been eroded away for international investors by currency weakness. The lack of upward pressure on inflation in Japan means there is likewise little upward pressure on interest rates either. Indeed, in contrast to the Federal Reserve or Bank of England, the Bank of Japan has stuck to a policy course that is every bit as loose as it was in 2021. The result of this is money being sucked out of the Japanese system and into, for example, USD-denominated assets.
As is well known, Japan has been fighting against deflation for decades now without much success. So entrenched is this ‘immovable object’ of deflation in Japan that even the ‘unstoppable force’ of global inflation has only lightly nudged prices up. This might be surprising, but imported inflation (for example energy costs, to which Japan is highly susceptible) are not as big a factor in Japan as one might think. That’s somewhat a political choice. For example, the Japanese government’s response to rising energy input costs has been to directly pay the energy companies on the proviso that they keep prices down, rather than pass costs onto the consumer. On top of that there has been very little wage inflation, as Japan’s social contract prioritises full employment on the downside at the cost of giving up higher salaries on the upside. The net result is the sterilisation of inflation in Japan.
In contrast, one area in which the Japan looks very similar to other developed markets is in the stylistic preferences of investors in its equity markets. In Japan, as elsewhere, growth assets have been strongly out of favour while high-yielding stocks (most particularly those in commodity-related sectors) have outperformed. This undeniably creates headwinds for investors, as it has done for our own Japanese Equities strategy, but fundamentally we believe the Japanese market remains an attractive hunting ground with ample opportunity to add value across a market cycle.
That reference to ‘in yen terms’ is crucial, because any underlying outperformance of the Japanese equity market has been eroded away for international investors by currency weakness. The lack of upward pressure on inflation in Japan means there is likewise little upward pressure on interest rates either. Indeed, in contrast to the Federal Reserve or Bank of England, the Bank of Japan has stuck to a policy course that is every bit as loose as it was in 2021. The result of this is money being sucked out of the Japanese system and into, for example, USD-denominated assets.
As is well known, Japan has been fighting against deflation for decades now without much success. So entrenched is this ‘immovable object’ of deflation in Japan that even the ‘unstoppable force’ of global inflation has only lightly nudged prices up. This might be surprising, but imported inflation (for example energy costs, to which Japan is highly susceptible) are not as big a factor in Japan as one might think. That’s somewhat a political choice. For example, the Japanese government’s response to rising energy input costs has been to directly pay the energy companies on the proviso that they keep prices down, rather than pass costs onto the consumer. On top of that there has been very little wage inflation, as Japan’s social contract prioritises full employment on the downside at the cost of giving up higher salaries on the upside. The net result is the sterilisation of inflation in Japan.
In contrast, one area in which the Japan looks very similar to other developed markets is in the stylistic preferences of investors in its equity markets. In Japan, as elsewhere, growth assets have been strongly out of favour while high-yielding stocks (most particularly those in commodity-related sectors) have outperformed. This undeniably creates headwinds for investors, as it has done for our own Japanese Equities strategy, but fundamentally we believe the Japanese market remains an attractive hunting ground with ample opportunity to add value across a market cycle.
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