How Long Will the Japanese Rally Last?

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The aggressive monetary policy of Japanese Prime Minister Shinzo Abe and the Bank of Japan (BoJ) has caused the island-nation’s currency to pass the 100 yen-to-the-dollar level and lift the price of Japanese equities. The question on the minds of many investors is: How much longer can Japan’s rally last?

With Japan’s recent rebound supported by the sharp decline in the yen’s value, there is only so much farther the yen can fall before any economic gains, if they remain sustainable, become merely asymptotic. With Abe and the BoJ needing more than a short-term effect, they are banking on the policy paying off for the long haul.

However, it is not as if Japan is the only economic region of the world trying to jumpstart its market. The euro zone is focused on bailing out some of its fiscally floundering nations. In the United States, the Federal Reserve has stimulated the markets, though the overall economy remains lackluster.

It is not as if all three economies can produce magic money out of thin air. In a global economy of give-and-take, something’s got to give. How much longer will Japan’s relative success in devaluing its currency, to reduce the price of its goods to spur exports and economic growth, be allowed to stand unchallenged?

Japan has put itself in a good position for now. Thanks to the BoJ’s policies, its first quarter 2013 results have been positive. Easy-money-fueled optimism and expectations for more gains in the future led to gains in both private consumption and exports. Though a weaker yen also has the inverse effect of raising import costs, the Japanese economy benefitted overall in its strong first quarter.

Eagle’s global guru, Nicholas Vardy, explained a couple months ago: “The weaker yen makes Japanese exports more competitive and boosts earnings from overseas for the household names among Japanese corporate giants… for every 10 yen the currency weakens against the dollar, profits of exporters would rise by 7% to 10%.”

However, the yen reached the 100-to-the-dollar level much quicker than many observers expected. Such a dramatic change could lead to volatility in the Japanese markets and leave little room for the gradual, steady improvement the BoJ and Abe desire.

To that end, the BoJ has taken action to move investors from safer bonds into equities in an effort to solidify the gains and growth of the Japanese economy. According to an official, “The BoJ is walking a very narrow path trying to engineer a gradual, not a sudden, rise in long-term rates backed by improvements in the economy.”

Others warn of the riskiness of Japan’s current path. “The bond market has been distorted by the BoJ. It’s reliant on central bank purchases more than ever, and a lack of liquidity will keep it vulnerable to sharp swings,” said Masaaki Kano, chief Japan economist at JPMorgan Securities.

Still, Abe has committed to these policies and their pace for the long term. He recently set a goal of tripling Japan’s infrastructure exports and doubling the country’s farm exports by 2020. In addition, he called for increased private investment to sustain and bolster economic gains. It remains to be seen whether or not Japan will manage to achieve these aims.

Whatever the future holds, it is important to remember that Japan, and its success or failure, does not exist in a vacuum. As the weakened yen profits from exports, the stability of Japan’s newfound resurgence depends upon whether others fail to retaliate. With inflation possible in the United States at some point due to the Fed’s own easing policies, the BoJ needs to keep its easing at least on a similar pace to maintain its ideal yen-to-dollar ratio. The question remains: in a world where everyone is trying to eke out profits and growth amid tough times, how much longer can Japan keep ahead of the game?

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