Glaring divergence in monetary policy between Japan and the United States becomes ever more apparent
Last month’s drift lower in the value of the Japanese yen versus the US dollar may not be over
Last month’s drift lower in the value of the Japanese yen versus the US dollar may not be over. The glaring divergence in monetary policy between Japan and the United States becomes ever more apparent even as both Tokyo and Washington are both heading, if in different ways, towards stances on tax that are more fiscally expansive.
In Japan’s case, the decision of Prime Minister Shinzo Abe to call a press stud Lower House election for October 22 has not only resulted in a reconfiguration of Japan’s political landscape but also resulted in a recalibration of intentions with regard to a hike in the country’s sales tax that is currently expected to occur in a year’s time.
While, if re-elected, Abe still plans to raise Japan’s sales tax to 10 per cent from 8 per cent in October 2019, the money raised, which had originally been earmarked for debt repayment, will now partly be deployed to finance investment in education and child care projects.
Yuriko Koike’s newly formed Party of Hope, Abe’s main opponent following the implosion of the Democratic Party of Japan, has already ruled out raising the sales tax rate and would therefore forego the revenue that could have been used, even in part, to reducing the size of Japan’s mountain of government debt.
It remains to be seen whether either set of proposals play well with investors.
As Mitsubishi UFJ Morgan Stanley Securities noted last week “with social security expenditure now making up 43.9 per cent of the basic general account budget (FY2017 initial budget), Japan’s fiscal flexibility is becoming severely compromised.”
Of course investors can be sure that the Bank of Japan (BOJ) remains resolutely set on maintaining its current ultra-accommodative monetary policy stance until its still distant inflation target of 2 per cent is met. Indeed last week’s summary of the BOJ’s September rate meeting deliberations cited one policymaker advocating yet more monetary easing.
In the United States, President Trump’s proposals for overhauling the US tax code, unveiled on September 27, while essentially a starting-point for negotiations with Congress, nevertheless included a call to lower the US corporate tax rate to 20 per cent from 35 per cent, a move that would arguably encourage more inward investment and chime with Trump’s “America First” election mantra.
That figure appears to be set in stone. “20s my number so I‘m not negotiating that number. I am not going to negotiate,” Trump said.
Again, it remains to be seen if investors will buy into the Trump Administration’s tax plans once, after negotiations with Congress, there is a clearer understanding of whether tax cuts can be funded without the need for additional US government borrowing.
But if investors cannot be certain how Trump’s tax plans will develop as a whole, aside the US President being wedded to a 20 per cent corporate tax rate, there is arguably a greater degree of clarity about the Federal Reserve’s continued determination to tighten US monetary policy both through balance sheet reduction and rate hikes.
Friday’s US Core Personal Consumption Expenditures (PCE) Price Index, the Fed’s preferred measure of inflation, may have slowed to a 1.3 per cent rise year on year in August from July’s 1.4 per cent print, but that won’t necessarily deter the US central bank from a rate hike, as markets see it, in December.
“It would be imprudent to keep monetary policy on hold until inflation is back to 2 per cent” Yellen said on September 26, adding that the Fed “should also be wary of moving too gradually.”
Investors might also wish to bear in mind that while Yellen, whose term as Fed Chief expires in February, could be re-appointed, President Trump is also weighing up other candidates and is set to announce a decision in coming weeks.
One candidate is a former Fed governor, Kevin Warsh, who has previously been vocal in his criticism of the Fed’s monetary stimulus policies. His appointment would likely see markets assuming the Fed will adopt a more hawkish line.
Either way, even the Fed’s existing stance is a world away from the Bank of Japan’s continued adherence to a short-term interest rate target of minus 0.1 per cent and a determination to keep 10-year Japanese government bond yields around zero per cent.
On balance there seem rather more reasons why investors might currently wish to hold the US currency to that of Japan. The yen’s poor performance versus the US dollar in September may continue as autumn unfolds in Asia. The yen may fall in the Fall.