The drop in Japan’s 3rd quarter GDP does not mark the start of a recession, but it does underscore that neither the Bank of Japan (BoJ) nor fiscal policy have room to change……
By Jesper Koll, Head of WisdomTree in Japan
If at all, the GDP report confirms BoJ Governor Kuroda`s recent assertion that the balance of risk to the macro economic outlook has become more asymmetric, tilted towards the downside.
All said, the GDP report strengthens our conviction that Japan will de-couple further from the US policy mix.
The BoJ stays steadfast at zero-rate-yield -curve-control and “Team Abe” is poised to ease fiscal policy with a pro-growth budget expected to be presented before year-end.
The details of the GDP report show an annualized contraction of 1.2% in real GDP.
The weakness was broad-based, with the largest negative contribution from public investment (-0.4ppt); and negative contributions from consumption, net-exports and inventories (all -0.3ppt) and private capex (-0.1ppt). While a string of natural disasters during the late summer explain some of the downside volatility, some more fundamental trends need careful watching :
Household savings continue to surge, with the household savings rate up by 1% of GDP since the end of last year.
While workers compensation continues to rise – up for seven consecutive quarters, the longest positive growth trend in over twenty years – consumer spending continues to lag the rise in incomes. Specifically, since the end of last year, workers compensation rose Y6.4 trillion but consumer spending only rose Y1.3%. This relentless build-up of consumer pre-cautionary balances poses a key policy challenge to “Team Abe”. To fix would require fundamental reform in the social security and healthcare system, which is politically unpopular (and economically meaningless without significant cuts in entitlements — which is exactly why the savings rate is rising as consumer prepare for the worst).
Business Investment back-up to 16.7% of GDP, the highest level in over 30-years
The bullish case for Japan is dependent on a structural up-shift and up-grade in the productive capital stock. The case is strong, supported by rapid technological change, the low financing cost, deregulation, and Japan`s favorable competitive position (for example, onshoring).
Survey data is unanimous in suggesting a strong domestic capex cycle is underway. However, from a macro-economic perspective the already extraordinarily high share of private investment spending in GDP does suggest the limits to growth may start to come into sight.
At the very least, the end of the pre-Olympic construction boom should start to put some downward pressure on capex as a growth driver from mid-2019.
Stay bullish capital-deepening and productivity enhancing capex, but expect more concerted efforts from policy initiatives to counter the coming downdraft in private sector construction orders. Here, public orders for re-construction of this summer`s disaster areas provide a welcome buffer.
Housing Investment up for the 1st time in five quarters
Good news from the residential construction front. Here, the BoJ adoption of negative interest rates had triggered a surge in activity as mortgage rates fell to record lows in the spring of 2016.
This mini-boom turned into a mini-bust by mid-2017, with housing activity contracting for five consecutive quarters.
Now we got a first up quarter, which hopefully confirms our fundamental view that residential housing is in a multi-year structural uptrend, driven by rising demand for private homes and condominiums from the new middle class now rising in Japan.
Household formation continues to rise, with marriage rates rising and birth-rates, slowly but surely, also on an uptrend.
The next couple of quarters should see continued positive housing investment to help verify our structurally positive view.