Shinzo Abe’s so-so victory in Japanese elections over the weekend will keep his focus on the Japanese economy, where it should be. The prime minister’s ruling coalition won a majority in Japan’s upper house, but slack turnout denied him enough seats to scrap the country’s constitutional commitment to pacifism. That clears away an unhelpful political distraction.
The world’s third-largest economy is having a rough year. Better workforce participation, inflation and business investment have been offset by trade war tensions. The benchmark Topix index is down roughly five per cent from the year’s peak in April. US President Donald Trump has deemed automobile imports a security risk, threatening an industry that is one of Japan’s largest employers. And Toyko has unwisely lowered itself into a trade spat with South Korea, a major market for Japanese products ranging from electronics to beer.
A strengthening yen is a bigger potential headache. The soft currency supported Japanese exporters, and also helped the country sustain its unorthodox monetary policy. Stock market heavyweights like $187 billion automaker Toyota Motor have baked exchange rates of around 110 yen to the dollar into their sales forecasts - and Topix-listed companies earn two-thirds of their revenue overseas, according to Wisdomtree estimates. If the yen firms, the reported value of sales outside from Japan mathematically decreases — more bad news for equities.
The risk of a further yen rally rises as other central banks consider easing, as the US Federal Reserve Board and European Central Bank have signalled. Japan’s benchmark interest rates are around zero so they can’t really go lower. Lower yields on US sovereign bonds will increase the relative attractiveness of their Japanese equivalents to investors, pushing the currency up further. That will make it even harder for Japan to put rates up and prune massive government debts incurred by stimulus efforts. A weak economy could also throw a wrench into Abe’s plans to hike the sales tax.
Had Abe’s coalition won two-thirds of the upper house, his administration might have turned to pushing through a controversial constitutional amendment releasing the Japanese army from pacifist constraints. But trade wars, not real wars, are the areas in which his efforts are best focused.