What Bank of Japan Stimulus Means for U.S. Stocks - Analyst Blog

Bank of Japan (BoJ) governor Haruhiko Kuroda has just stepped up the ambitious program launched by Prime Minister Shinzo Abe to resuscitate the Japanese economy. Last Friday, the BoJ governor announced that it will expand its monetary stimulus by stepping up asset purchases.

Kuroda warned that the country is at a ‘critical moment' in its fight to get out of deflation. He also said this is “Bank of Japan's unwavering determination to exit deflation.”

This adds another dimension to the much-touted “Abenomics” policies which the current government has used to boost the economy. At the same time, it may have global implications of a far reaching nature.

Monetary Stimulus Expanded

The BoJ announced that it will step up asset purchases to 80 trillion yen on annual basis. This is a significant increase from its earlier announced target range of 60-70 trillion yen. The decision was not a unanimous one. Four of the BoJ board members voted against the proposal to expand monetary stimulus while five were in favor of the move.

A statement by BOJ noted: “Japan's economy has continued to recover moderately as a trend and is expected to continue growing at a pace above its potential. However, on the price front, somewhat weak developments in demand following the consumption tax hike and a substantial decline in crude oil prices have been exerting downward pressure recently. If the current downward pressure on prices remains, there is a risk that conversion of deflationary mindset, which has so far been progressing steadily, will be delayed.”

Markets responded positively to the announcement, with the benchmark Nikkei surging 5%. Stocks also gained worldwide, welcoming the stimulus program. Monetary stimulus is one of the pillars of Prime Minister Shinzo Abe's economic policies, widely known as Abenomics.

These policies have three primary “pillars.” Fiscal and monetary stimulus will be utilized, along with structural reforms which impede growth of one of the world's largest economies. Such measures include getting Japanese companies to produce within the country and increasing the proportion of women in the country's workforce.

Is Abenomics Failing?

Several market watchers are of the opinion that the enlargement of monetary stimulus is in effect an acceptance of the fact that structural reforms have not been undertaken. This also means that the opportunity for effecting significant change may have been lost.

The current measure specifically targets a 2% rate of inflation. All are in unison when it comes to the fact that Abenomics has successfully stopped a 15-year decline in prices. However, wages have not increased, women have not been integrated into the workforce and exports have not seen any significant enlargement.

The idea behind greater monetary stimulus is to spur inflation. This is expected to boost wages in turn and put more money in the hands of consumers, which will then trigger higher growth. However, previous monetary stimulus measures have failed to do so. The economy's performance remains poor with most analysts attributing Japan's woes to the consumer tax.

Immediately before the introduction of such a tax, consumers rushed to make higher purchases. However, as the sales tax came into effect purchases dropped, leading to a cooling off in the economy. The hike in sales tax in April from 5% to 8% led to annual consumer inflation dropping to 1% in September. This was half of what the country's central bank's target is. (Read: Japan GDP May Slump Amid Other Troubles)

Global Implications

The introduction of monetary stimulus has resulted not only in gains for the stock markets, but has also pushed the yen sharply downward. Bond prices have also gained, but some analysts are of the view that the central bank's action could trigger of what is currently being described as “currency war.”

As additional monetary stimulus is introduced, the country's currency plummets. This in turn makes exports cheaper, leading to gains for the country whose currency has undergone devaluation. To date, central banks all over the world have largely ignored the BoJ's monetary stimulus program. This is primarily because the size of the BoJ's bond purchases has not been significant. However, it is worth taking note of the fact that the BoJ has maintained a zero interest rate longer than the US Federal Reserve.

The Fed has promised to maintain record low rates for a “considerable time,” a much smaller time period than the BoJ. It has also wound up its large program of bond purchases and has indicated that improving labor market conditions could trigger an increase in interest rates.

The European Central Bank (ECB) has also taken several measures to boost the Eurozone's flagging economy. However, it has resisted the need to undertake quantitative easing and is still mulling over such a response. However, the BoJ's action may put additional pressure on the ECB to follow suit.

As for the US, given the economic conditions prevailing in the country, it is unlikely that any new monetary stimulus is in the offing. At the same time it is significant to note that monetary stimulus from a central bank may add to pressure on other central banks to act along similar lines. This could extend the “considerable time” that the Fed takes to raise interest rates.

Markets React

The announcement not only boosted Nikkei but helped key global benchmarks end higher last Friday. The US markets too ended significantly higher on Oct 31. The Dow reached a record high and witnessed its biggest weekly gain in around two years. The Nasdaq also touched its highest level since Mar 2000. The S&P 500 also finished at record level on Friday.

Meanwhile, Japan's currency yen slumped to an almost seven year low against the dollar. The US dollar soared to 111.53 yen, hitting a peak since Jan 2008. Interestingly, some believe that weaker yen will make exports cheaper, leading to a positive impact on trade balance. Abe himself commented: “It's (weak yen) positive for exporters and companies doing business overseas.”

Stocks in Focus

Among the Japanese ADRs that scored decent gains following the announcement of the stimulus measure, Honda Motor Co., Ltd. (HMC), Canon Inc. (CAJ), Nidec Corp. (NJ), Toyota Motor Corp. (TM), Sony Corp. (SNE) surged 4.8%, 2%, 3.7%, 4.7% and 5.9%, respectively.

However among these, Toyota Motor and Canon are the only ones carrying Zacks Rank #1 (Strong Buy) and are expected to witness further gains. While Sony carries a Zacks Rank #3 (Hold), Honda and Nidec currently hold a Zacks Rank #4 (Sell).

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