In all the market euphoria over recent policy moves in Beijing, global investors seem to be missing the signals emanating from Tokyo or Seoul.
Japan’s economy unexpectedly shrank in the July-September quarter. The annualized 1.2% contraction in gross domestic product came despite the yen’s 30% depreciation at the time. Though the yen has bounced back by nearly 10% since then, its highly competitive level during the third quarter did little to support growth via exports.
That suggests the post-Covid-19-era recovery in global growth isn’t panning out as hoped. And for that, officials in Tokyo may have Chinese leader Xi Jinping to thank. Xi’s massive Covid lockdowns effectively put Asia’s biggest economy and top trading nation in neutral, if not full reverse.
South Korea can attest. Much of the 5.7% drop in Korean exports in October year-on-year bears Chinese fingerprints. So does the 2.8% on-year slide in overseas shipments in the first 10 days of November.
The caveat, of course, is that Xi’s government finally appears to be easing its “zero Covid” policy. His economic team also just unveiled a 16-point plan to stabilize a cratering property market. We’ll see, as Covid cases surge anew in major cities like Beijing and Guangzhou. We’ll see, too, as Xi’s reform team realizes the severity of the troubles facing the property industry, one that can generate as much as 30% of GDP.
Nor does the People’s Bank of China have good options to support Chinese growth via fresh liquidity. The yuan’s 11% decline this year is adding to the pressures on highly-indebted developers struggling to avoid default in overseas borrowing.
This leaves Japan in a particularly tough spot. The Bank of Japan’s balance sheet already exceeds the size of the $5 trillion economy. Inflation, meantime, is racing well ahead of the 2% target at a moment when a weak yen has Japan importing commodities at elevated prices.
Not surprisingly, Prime Minister Fumio Kishida’s government is hinting at even bigger stimulus packages. For now, Tokyo is waiting to see how the extra budget worth 29.1 trillion yen ($208 billion) it unveiled in late November affects growth.
At the time, Kishida said “I will do my best to deliver various measures in this comprehensive economic package to the people so that they can feel that we are supporting their lives,” just as data showed prices in Tokyo in October were rising at the fastest pace since 1989.
Odds are, Kishida’s team will be sending more in the months ahead as China flatlines and Federal Reserve rate hikes increase U.S. recession risks.
Japan faces an unexpected headwind: the weak yen is doing more to hurt business and household confidence than boost exports or corporate profits. The problem, as Harumi Taguchi at S&P Global Market Intelligence told Bloomberg: “When the yen falls this fast, companies face a tough situation in that they are hit by higher import costs of materials while they can’t easily pass on costs to exports when overseas economies are slowing down.”
Again, the yen recovered a bit in recent days as U.S. inflation eased to 7.7% in October year-on-year. That convinced markets that the Fed’s days of tightening in 75 basis-point intervals are over. Well, hopefully. But then the Covid surge in China could easily reignite supply chain-related inflation. And between Vladimir Putin’s Ukraine war and OPEC’s intransigence, energy prices could explode anew.
That would have Fed Chairman Jerome Powell’s team tapping even harder on the brakes. The yen, in turn, could easily return to the 145 to 150 range versus the dollar, setting off a new cycle of nail-biting about the health of Asia’s second-biggest economy.
“While there are calls for the BOJ to raise interest rates, a quarter-century of near-zero interest rates has turned Japan into a low-interest-rate addict,” says Richard Katz, who publishes The Oriental Economist Report. “With 16% of all loans charging interest of less than 0.25% and 70% less than 1%, a host of companies would suddenly become insolvent if forced to pay substantially higher rates. Currently, the economy is too fragile to raise rates enough to make much of a dent” in the U.S.-Japan rate gap.
Over in the No. 4 economy, Bank of Korea Governor Rhee Chang-yong is under fire for raising rates too aggressively. Such fears also bear Chinese fingerprints. As China grows the slowest in 30 years, Korea is running into intensifying headwinds.
Looked at in the context of Japan’s troubles, the view that China’s economy is now out of the woods needs revision.