Monthly Economic Report

Transcription

1 Monthly Economic Report November 19, 218 Copyright Mizuho Research Institute Ltd. All Rights Reserved.

2 1. Overview of financial markets: the results of the US midterm elections were as expected. But uncertainty in the global economy is weighing on the market Japanese and US stock markets rallied, reflecting the results of the US midterm elections that were as expected. Even so, the topside remains heavy due to the market s focus upon uncertainties in the global economy such as the direction of US-China trade tensions and China s economic slowdown. The 1-year US Treasury (UST) yield is moving in the 3% range. Amid the ongoing appreciation of the dollar, the Euro has edged down due to concerns regarding Italy s fiscal conditions, Germany s political situation, and the UK s Brexit negotiations. (End of Dec 216 = 1) Japan (Nikkei 225 Average) MSCI Emerging Germany (DAX) US (Dow Jones Average) 95 17/1 17/5 17/9 18/1 18/5 18/9 [ Major market trends ] (%) 1yr UST (%) yr German bonds (rhs) 1yr JGB (rhs) (yy/m) 1. 17/1 17/5 17/9 18/1 18/5 18/ (yy/m) (End of Dec 216 = 1) JPY 88 USD 86 EUR 17/1 17/5 17/9 18/1 18/5 18/9 (yy/m) Note: The currency exchange rates are the nominal effective exchange rates in the figures published by the authorities of each country. Source: Made by MHRI based upon Bloomberg 1

3 Leading indicators suggest an economic slowdown, concerns toward growing uncertainty Leading economic indicators suggest an economic slowdown from the second half of 218 to the first half of 219. The recovery momentum should gradually fade. Leading indicators indicate a clear slowdown of the overall OECD economies led by the Eurozone and Japan. There are signs that the US economy has also peaked out. The Economic Policy Uncertainty Index is rising mainly with respect to China, suggesting the rise of uncertainties due to concerns regarding US-China trade tensions. [ OECD Composite Leading Indicators ] [ Economic Policy Uncertainty Index ] (Long-term average = 1) OECD US Eurozone Japan Suggesting economic slowdown (Pt) Global China (rhs) (Pt) (yyyy) (5) (yy) Source: Made by MHRI based upon OECD Source: Made by MHRI based upon Economic Policy Uncertainty 2

4 2. The US economy: strong growth driven by personal consumption and inventory investment in the Jul-Sep quarter US real GDP growth in the Jul-Sep quarter (advance estimate) revealed a strong expansion at an annual rate of +3.5% q-o-q. Personal consumption and inventory investment contributed to the strong growth. However, housing investment worsened for the third quarter in a row. The impact of interest rate hikes and the shortage of construction workers and properties and land for sale were among the background factors. Capital investment was also low due to the deterioration of investment related to crude oil drilling in response to the pause in the rise of oil prices, and the slowdown in machinery investment due to concerns regarding trade tensions. External demand also served as a drag. Exports declined, mainly with respect to exports to China (impact of the retaliatory tariffs) and Europe. Imports increased sharply for the first time in three quarters, driven by strong consumption. (Y-o-y % change) 6. Government spending [ Real GDP growth rate ] Net exports Inventory investment Housing Investment Real GDP Capital investment Personal consumption Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q (qtr) (yyyy) Source: Made by MHRI based upon US Department of Commerce 3

5 ISM indexes are at high levels. Even though the current slowdown of capital investment appears to be temporary, downside risks are a concern In October, both the ISM manufacturing index (57.7) and ISM nonmanufacturing index (6.3) stood at firm levels. On the other hand, both shipments and new orders for core capital goods are currently levelling off. According to the ISM, additional tariffs and the rise of procurement costs pose challenges for both manufacturers and nonmanufacturers. The ISM export orders index indicates a significant fall among manufacturers. While the export orders index among nonmanufacturers is still high, there are concerns regarding the impact of the overseas economic slowdown. In September, new orders and shipments of core capital goods levelled off. This was due mainly to the slowdown in medical electronic, measurement, and control equipment, which had served as the drivers from 217 onward. In the Federal Reserve Bank manufacturing survey, the expectations index and the capital investment outlook are declining in both the NY and Philadelphia areas. There are clear concerns about the future. (Base = 5) Inventories Employment New orders [ ISM manufacturing index ] [ Core capital goods ] Delivery delays Production Manufacturing 57.7 (213 = 1) New orders Shipments (m/yyyy) Source: Made by MHRI based upon US Institute for Supply Management Source: Made by MHRI based upon US Department of Commerce (yyyy) 4

6 Even though the current economic expansion is in a late stage, strong payroll growth is continuing. This should serve to support strong consumption In October, nonfarm payrolls rose a dramatic +25 thousand m-o-m. Even in terms of a 3-month average, the pace exceeds 2 thousand per month. The unemployment rate remains at a historically low level of 3.7%, and the labor participation rate and employment rate have also improved (in October +.2% pt m-o-m). Hourly wages reached the 3% y-o-y range (next page). The favorable labor market conditions should continue to support personal consumption. In October, automobile sales increased for the second straight month, to million vehicles (annualized rate). In spite of the global stock market fall, the consumer confidence index (Conference Board) rose further in October. [ Nonfarm payrolls and unemployment rate ] (M-o-m change, thousand people) (Annual rate, million vehicles) 19 [ Automotive sales (number of vehicles) ] million vehicles (yyyy) (yyyy) Source: Made by MHRI based upon US Department of Labor Source: Made by MHRI based upon Autodata 5

7 Hourly wages showing their strongest growth since 29. Inflation rate remains at a level near 2% Inflation indicators remain at a level near 2%. Hourly wages (y-o-y ch) is currently rising. In October, hourly wages continued to grow strongly at a pace of +.2% m-o-m. On a year-on-year basis, hourly wages grew +3.1% y-o-y. In October, the rate of rise in the core CPI declined slightly to +2.1% y-o-y. Even though negative pressures upon goods prices eased slightly, service prices edged down. In September, the core PCE deflator (+1.97% y-o-y) remained more or less unchanged from the previous month, and continued to grow at a pace near 2%. [ Hourly wages and inflation rate ] (Y-o-y % change) % (Oct.) % (Oct.) +1.97% (Sep.) Hourly wages Core CPI Core PCE deflator Source: Made by MHRI based upon US Department of Labor, Bureau of Labor Statistics (yyyy) 6

8 FRB s stance to continue interest rate hikes Taking into account the large amount of support for a tightening policy at the September FOMC and the outlook that growth exceeding the potential growth rate will continue, there is a high likelihood that interest rate hikes will be continued. The FOMC will closely monitor the firming of inflationary pressures, greater room for companies to raise prices, and the leveraged loans market. On the other hand, there are many factors tightening financial conditions, such as the economic slowdown in China and Europe, dollardenominated debt among the EMs and intensification of US-China trade tensions. [ Summary of the Minutes of the September FOMC ] Trade tensions Employment and wages Prices Finance Companies have indicated that the steel and aluminum tariffs in particular are a factor causing a decline in new investment in the energy sector. Farm sources have indicated that grain prices inside the US are declining due to the retaliatory tariffs by China. The labor market is tightening, so the companies are responding by raising remuneration and additional benefits, improving the workplace environment, and offering vocational training. [The participants largely agreed ] on the judgment that an overall increase in labor costs can be detected, but stagnation in the productivity growth rate, etc. is also reflected, and the wage growth rate is at an historically low level. [Several participants ] indicated that there is probably a situation in which the inflation rate will rise above 2% gradually. There are many reports on some firming of inflationary pressures, and in addition there are reports that input costs are rising due to the strength of demand and tariffs. [Several participants ] indicated that companies facing upward pricing pressure due to tariffs have begun to think that their room for raising the prices of their own products has expanded. [A couple of participants ] judged that the gradual rise in inflationary expectations is important for achieving sustained inflation targets. [A number of participants ] noted that financial conditions remained accommodative: The rise in interest rates and appreciation of the dollar over the intermeeting period had been offset by increases in equity prices. Theimpact of the interest rate rises and appreciation of the dollar since the previous meeting has been offset by high stock prices. [Some participants ] mentioned the increase in balances, relaxation of lending standards, and rise of non-banks with regards to the leveraged loans market, and indicated that sufficient care should be taken to monitor risks related to financial stability. Risks and uncertainty Negative yield Tightening Neutral interest rate [Some participants ] indicated that trade policy is a source of uncertainly with respect to the future of the economy and prices. Disparities between domestic and foreign economic and finance policy are a risk for slowdown of the economy through further appreciation of the dollar. [Some participants ] indicated that if the financial stress occurring in some EMs spread to the global economy and financial markets, there would be an additional (slowdown) risk. The participants indicated that a variety of factors are upward swing risks: the high confidence of consumers, the accommodative financial conditions, and a greater fiscal stimulus effect than anticipated. Regarding inflation, the tightening of the resource utilization rate and the greater room for companies to raise prices present the risk of an upward swing. Lower growth than anticipated, appreciation of the dollar, and the stagnation of inflationary expectations are slowdown risks. [A few participants ] mentioned the suggestion of a negative yield. According to the rule of thumb, the view that could become a signal of an economic recession. On the other hand, there is also the view that trust in the signal is declining due to the buying in of assets by central banks, and the possibility of a negative yield due to the rise in the current long-term interest rate is a recession in the short term. [A few participants ] indicated that gradual tightening was necessary for the time being. [Many participants ] indicated that rate hikes greater than the long-term level were necessary temporarily in order to avoid the risk of a sustained upward swing in inflation and a financial imbalance. [A couple of participants ] indicated that they did not like the tightening stance. [Many participants ] noted that future adjustments to the target range for the federal funds rate will depend on the evaluation of incoming information and its implications for the economic outlook. In this context, estimates of the level of the neutral federal funds rate would be only one among many factors that the Committee would consider in making its policy decisions. Source: Made by MHRI based upon FRB 7

9 US bond market: US treasury yields should trend around the lower half of the 3% range amid the absence of the rise of concerns regarding the acceleration of inflation Given the risk-off sentiment due to rising uncertainties about the future, the 1-year UST yield has declined to the 3.% range. Crude oil prices have fallen to the same level as previous year, and the expected inflation rate has declined. Subsequent to a succession of dovish statements by FRB officials, the impact of factoring in the interest rate hike has faded. Despite the strength of the US economy, inflationary pressures are not rising. Thus, the long-term interest rate is forecast to trend around the lower half of the 3% range. If the market focuses upon the end of interest rate hikes, it would serve as further downward pressures upon the longterm interest rate. [ 1-year UST yield and expected inflation rate ] [ US federal funds rate outlook of market participants ] (%) Crude oil price (rhs) 1yr UST bond yield Expected inflation rate (Y-o-y % change) 1 85 (Multiple) /11 18/2 18/5 18/8 18/11 (yy/mm) Note: Expected inflation rate is the breakeven inflation rate (1-year) Source: Made by MHRI based upon Bloomberg Number of interest rate hikes in 218 Number of interest rate hikes in (mm) Note: Interest rate hike path from the perspective of the FF rate futures market; the 218 data includes the portion already implemented. Source: Made by MHRI based upon Bloomberg 8

10 US stock market: future uncertainties will tend to restrain the topside. Risk factors still abound While the stock market partially regained its earlier losses and the VIX index fell below 2 around the US midterm elections, market volatility is rising again due to numerous concerns raising future uncertainties, such as the Trump administration s stance toward the US-China Summit, the political situation in Europe, the Chinese economy, and the pace of FRB interest rate hikes. Progress in US-China tensions, if any, will serve as a positive market-moving factor. However, the rise of a more cautious view with respect to the global economy and a sharp rise in the US long-term interest rate, etc. are risk factors. While the forward P/E ratio in terms of valuation has declined to the 15x range, the level compared to bonds remains unchanged. Even though Jul-Sep quarter corporate earnings revealed a better-than-expected improvement, future outlooks were revised downward in (Index) many cases. [ S&P5 index and VIX index ] China shock UK referendum VIX shock (Pt.) 3,2 3, 2,8 2,6 (USD) [ Change in the forward EPS for 218 and 219 of S&P 5 Index companies ] (USD) ,4 2, , US presidential VIX index 5 election S&P5 index (rhs) 15/1 15/7 16/1 16/7 17/1 17/7 18/1 18/7 1,8 1,6 1,4 (yy/m) Note: The VIX index is the option implied volatility indicator of the S&P5. It is said to gauge the fear sentiment of investors, with a reading of 2 indicating a rise in their fear sentiment. Source: Made by MHRI based upon Bloomberg (rhs) /4 18/5 18/6 18/7 18/8 18/9 18/1 18/11 (yy/mm) Source: Made by MHRI based upon Datastream 9

11 3. The European economy: real GDP growth slowed in the Jul-Sep quarter Eurozone real GDP grew +.2% q-o-q, marking the lowest pace of growth since the Jan-Mar quarter of 213. While the components of demand are yet unknown, it looks likely that capital investment and exports slowed down. On a country basis, it appears that Italy and Germany slowed down. Even though the Purchasing Managers' Index (PMI) with a high correlation with GDP, is higher than the expansion-contraction threshold of 5, the index has declined since 218. Given the rise of the inventory DI together with the decline of the PMI, it appears that there has been an unintended rise of inventories. [ Eurozone: real GDP growth ] [ Eurozone: PMI and inventory DI ] (Y-o-y % change) (Pt) 6 58 PMI Inventory DI (rhs) (DI) 7 Inventory excess Inventory and error Net exports -1. Gross fixed capital formation Government consumption -1.5 Household consumption expenditure GDP Source: Made by MHRI based upon Eurostat (yy) Note: This asks whether or not there is a surplus compared to a normal inventory level. Zero is the threshold value for the judgment. Source: Made by MHRI based upon European Commission, Markit (yy) 2 1 Inventory shortf all 1

12 The ECB kept policy unchanged at the October Governing Council meeting While the ECB Governing Council meeting on October 25 kept the existing monetary policy framework, it lowered asset purchases to 15bn euros a month. The next ECB President is yet to be decided. Since the selection the new president is determined in relation to decisions on other ECB Governing Council members and top EU officials, attention will focus upon the successor to Daniele Nouy (France), whose term as Chair of the ECB Supervisory Board expires in December 218. [ Finance policy outlook of the ECB ] [ Major ECB and EU posts approaching term deadlines ] (%) Monthly asset purchase amount of the ECB (rhs) Marginal lending interest rate Major refinancing operations interest rate Deposit facility interest rate Core inflation rate (Forecastof MHRI) (1 billion EUR) Title Name Nationality Term expiration European Central Bank Supervisory Board, Chair Member of the Executive Board and Chief Economist of the ECB European Parliament President Daniele Nouy France December 31, 218 Peter Praet Belgium May 31, 219 Antonio Tajani Italy July European Jean-Claude Juncker Luxembourg November 219 Commission President.5 2 ECB President Mario Draghi Italy October 31, (yyyy) -2 European Council President (EU President) Member of the Executive Board of the ECB Source: Made by MHRI based upon ECB and EU Donald Tusk Poland November 219 Benoît Cœuré France December 31, 219 Source: Made by MHRI based upon ECB 11

13 German interest rates are likely to remain low for the time being due to demand for safe assets amid risk-off market sentiment The German 1yr government bond yield fell to the mid-.3% level, as the political uncertainties in Italy and the UK and signs of Eurozone economic slowdown served as negative pressures upon investor sentiment. The Eurozone October PMI and Jul-Sep quarter GDP results fell short of forecasts, leading to the decline of German long-term interest rates. The difficulties in Italy s budget talks for the next fiscal year are keeping the yield on Italian government bonds high. As the current risk-off sentiment is expected to continue for the time being, the yield on German long-term government bonds should remain low. While the market has been factoring in the policy interest rate hike next year, this has more or less faded. (%) 4. [ Yield on European 1yr government bonds ] [ Deposit facility interest rate outlook among market participants ] (%) Italy Spain (mm) Source: Made by MHRI based upon Bloomberg France -.38 Germany -.4 9/26 1/3 1/1 1/17 1/24 1/31 11/7 11/14 (mm/dd) Note: The level of the deposit facility interest rate as of September 219 from the perspective of the OIS rate. Source: Made by MHRI based upon Bloomberg 12

14 4. The Chinese economy: the economy has entered a stagnation The Chinese economy has entered a stagnation. Looking forward, there is the possibility that the slowdown of exports will intensify due to the impact of trade tensions, leading to a protracted stagnation. The business cycle clock of the diffusion index entered a stagnation from August 218. This is due to a more significant decline of retail sales and corporate earnings despite a slight upturn of investment due to economic stimulus measures. Overall exports remained strong. However, in terms of items subject to US sanctions, the contraction of the growth rate has intensified from July onward. Considering that the range of items subject to sanctions has been expanded from September, the odds are high that growth will contract also in terms of overall exports. [ Business cycle clock of the China diffusion index ] Slowdown 218/1 218/9 (Upswing from the trend) 213/1 217/1 212/1 214/1 Stagnation 215/1 Recovery (Downswing from the trend) 216/1 Expansion Notes: The diffusion index is synthesized upon standardization, detrending, outlier processing of the six indicators of production, total retail sales of consumer goods, fixed asset investment, exports, the job opening-to-application ratio, and corporate earnings, and synthesized using the same weights. The Y-axis shows the upswing/downswing from the trend, and the X-axis shows the time series variation of the cyclical components (m-o-m ch). Source: Made by MHRI based upon National Bureau of Statistics of China, General Administration of Customs of China, etc [ Exports to the US of items subject to US sanctions] (Y-o-y % change) 3 8/23 Items subject to US sanctions 7/6 Items subject to US sanctions 17/1 17/4 17/7 17/1 18/1 18/4 18/7 (yy/m) Notes: Items subject to sanctions by the US are collated at the HS 6-digit level. Source: Made by MHRI based upon US Department of Commerce 13

15 5. The Japanese economy: the rate of real GDP growth fell into negative territory for the first time in two quarters in the Jul-Sep quarter (-1.2% q-o-q) Japan s real GDP contracted (-1.2% q-o-q) in the Jul-Sep quarter, falling into negative territory for the first time in two quarters. A series of natural disasters including the heavy rains in western Japan, Typhoon No. 21, and the Hokkaido earthquake led to store shutdowns, suspension of factory operations, and severance of logistics networks, serving as negative pressures on consumption and exports. Capital investment also grinded down to a pause due to a backlash to the strong growth in the Apr-Jun quarter. The recovery from the natural disasters is proceeding smoothly, and production is beginning to recover. However, the shipments-inventory balance is deteriorating primarily for electronic components and devices, leading to views that the pace of rise of production will only be gradual. (Y-o-y % change) [ Japan: quarterly real GDP ] External demand Public demand Private inventory investment Private capital investment Household (private consumption + housing) Real GDP Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q (qq) (yyyy) (215=1) [ Japan: indices of industrial production ] Shipments-inventory balance (rhs) Industrial production 92 15/1 16/1 17/1 18/1 Forecast index Revised figure (%Pt) (yy/mm) Source: Made by MHRI based upon Cabinet Office, Preliminary Quarterly Estimates of GDP Source: Made by MHRI based upon Ministry of Economy, Trade and Industry, Indices of Industrial Production 14

16 Natural disasters: natural disasters pushed down goods and services exports in the Jul-Sep quarter The impact of the series of natural disasters was a factor pushing down goods and services exports in July-September. In July, exports from the ports of Kobe and Moji fell due to the impact of the suspension of factory operations due to the heavy rains in western Japan. In September, exports from Osaka fell due to the temporary closure of Kansai International Airport caused by Typhoon No. 21. In addition to the temporary closure of the airport, concerns regarding natural disasters led to a decline in number of foreign visitors. In September, the number of foreign visitors to Japan fell below the previous year for the first time in 68 months. [ Trends in exports (customs house-basis, value-basis) ] [ Number of foreign visitors to Japan ] (Y-o-y % change) 2 15 Tokyo Kobe Nagoya Other Yokohama Osaka Moji Overall (Y-o-y % change) 8 6 Other Europe, North America, and Australia ASEAN NIEs China Overall Lower than the previous year for the first time in 68 months /1 17/12 18/2 18/4 18/6 18/8 (yy/mm) -2 14/1 14/7 15/1 15/7 16/1 16/7 17/1 17/7 18/1 18/7 (yy/m) Note: The Hakodate, Nagasaki, Okinawa areas are a small proportion relative to overall, so they are combined together under Other." Source: Made by MHRI based upon Ministry of Finance, Trade Statistics Source: Made by MHRI based upon Japan National Tourism Organization 15

17 Employment and consumption: amid the continuation of strong labor market conditions, consumption should follow firm footing Amid the continuation of strong labor market conditions, personal consumption should also follow firm footing. The unemployment rate is at a level in the lower half of the 2% range, and the number of employed persons has increased moderately. Given the ongoing shortage of labor, the unemployment rate should continue to hover low. Given prospects that the number of employed persons will gradually increase due to factors such as the labor force participation of the elderly, disposable income should also follow firm footing. Despite temporary fluctuations before and after the consumption tax hike, personal consumption on average should follow firm footing. [ Unemployment rate and number of employed persons ] [ Outlook for disposable income and personal consumption ] (%) 4. Unemployment rate Number of employed persons (rhs) (1K people) 6,7 (Y-o-y % change) 3. Real consumption 2.5 Real disposable income Outlook 3.5 6, , , ,3 (yyyy) Note: Seasonally-adjusted Source: Made by MHRI based upon Ministry of Internal Affairs and Communications, Labour Force Survey (FY) Source: Made by MHRI based upon Cabinet Office, Annual Report on National Accounts 16

18 Government and prices: public investment was increased in the revised budget, core CPI (y-o-y ch) gradually slowed The government passed the first supplementary budget. According to trial calculations, FY219 nominal GDP will be pushed up around.2% due to an increase in public investment worth approximately 8 billion yen. In FY211, after the Great East Japan Earthquake, and FY216 after the Kumamoto earthquakes, public works-related expenses were supplemented by the passage of supplementary budgets. The odds are high that the budget supplementation in the second supplementary budget funded by increased tax revenues will reach around 2 trillion yen. An uptick in public investment is projected in FY219. Prices will likely peak in the Jan-Mar quarter of 219 and subsequently slow down. The rise of prices will gradually slow down due to a pause in the rise of energy prices. The measure to make early childhood education free in October 219 (CPI contribution of -.5% pt) will also serve as negative pressure. (JPY trillion) [ Public works-related expenses ] [ Consumer Price Index (CPI) ] Note: The figures for FY218 are provisional. Source: Made by MHRI based upon Ministry of Finance Supplemented amount Amount in initial budget (FY) (Y-o-y % change) CPI effect due to making early childhood education free Energy Food (excluding fresh food and alcoholic beverages) US-style core CPI General, excluding fresh food Outlook Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q Source: Made by MHRI based upon Ministry of Internal Affairs and Communications, Consumer Price Index (qtr) (yyyy) 17

19 Japanese monetary policy: the BOJ kept monetary policy unchanged at the October Monetary Policy Meeting Concerns regarding side effects growing The Bank of Japan (BOJ) kept policy unchanged at the Monetary Policy Meeting (MPM) in October (1/3 and 1/31). In the Outlook for Economic Activity and Prices (the Outlook Report ), the outlook for prices was lowered and the comments that it is necessary to closely monitor future trends" were added regarding the risks that should be monitored closely from the perspective of the management of monetary policy. The Financial System Report (October 218) implemented a quantitative evaluation of the tail risk. Its analysis indicated the growing risk of an economic slowdown in the future. The policy interest rate will most likely be kept unchanged until the consumption tax hike through forward guidance. Subsequently, there is a possibility that the BOJ will move to raise interest rates gradually within the range that can maintain the momentum of prices. [ Outlook Report (October 218) ] [ Financial vulnerabilities and economic fluctuation risk over (FY-o-FY % change) the next 3 years (GDP at Risk) ] Consumer Price Index (excluding fresh food) Real GDP Case excluding the impact of the rise in the consumption tax rate FY ~+1.5 (+1.4) Forecast made in July ~+1.5 (+1.5) FY ~+.9 (+.8) Forecast made in July ~+.9 (+.8) FY22 +.6~+.9 (+.8) Forecast made in July ~+.9 (+.8) +1.8~+2. (+1.9) +1.8~+2.1 (+2.) +1.9~+2.1 (+2.) +1.9~+2.1 (+2.1) +.9~+1. (+.9) +1.~+1.2 (+1.1) +1.3~+1.5 (+1.4) +1.3~+1.6 (+1.5) +1.4~+1.6 (+1.5) +1.4~+1.6 (+1.6) Note: This is the majority outlook of the BOJ Policy Board members. The figures in the brackets are the median values of the outlooks of the Policy Board members. Source: Made by MHRI based upon Bank of Japan Note: This is the probability distribution regarding the size of the change in the supplydemand gap (figures converted to the annual rate) over the next 3 years at each time displayed as a time series. Source: Bank of Japan, Financial System Report (October 218) 18

20 Japanese long-term interest rate: 1-year JGBs trending in the range centered around the mid-.1% level The yield on 1yr JGBs is falling slightly at around the.1%-level. While speculation on the BOJ s review of its government bond purchase operations restrains the fall of interest rates, demand for JGBs by investors such as life insurance companies stemming from concerns regarding a global economic slowdown and the rise of dollar funding costs serves as restraints upon the rise of interest rates. In addition to the reduction of government bond purchases, the odds are high that the BOJ will also go forward with the revision of purchase operations for the revitalization of the market. The yield curve should gradually steepen since the average maturity of government bonds purchased by the BOJ is becoming shorter due to the reduction in purchases of super long-term bonds. [ 1yr JGB yield trends ] [ Average maturity of government bonds purchased by the BOJ ] (%).2 (yrs) /9 17/12 18/3 18/6 18/9 (yy/mm) (yy) Source: Made by MHRI based upon Bloomberg Source: Made by MHRI based upon Bank of Japan 19

21 Japanese stock market: even though Japanese stocks are undervalued, lingering concerns regarding corporate earnings are keeping the topside heavy Even though Japanese stocks regained some of its earlier losses around the US midterm elections, the market softened once again reflecting the rise of concerns regarding the economy and corporate earnings amid a return of global market volatility. Overseas investors are heavy net sellers led mainly by futures. The forward P/E ratio has declined to nearly 12x. While there is room for a rise, the topside will most likely be heavy amid lingering concerns regarding corporate earnings. Given the absence of the rise of expectations toward future corporate earnings in the interim earnings results of companies at the end of the March, analyst forecasts are predominantly skewed toward downward revisions, and the TOPIX Revision Index has fallen to levels last visited in early spring of 216. [ Overseas investor trading and the Nikkei Stock Average (weekly) ] [ TOPIX Revision Index ] Net buying Net selling (1bn JPY) 2, 15, 1, 5, -5, -1, -15, Spot Futures Nikkei Stock Average (weekend closing price, rhs) Source: Made by MHRI based upon Japan Exchange Group and Bloomberg (JPY) 25, 24, 23, 22, 21, 2, -2, 19, 18/1 18/4 18/7 18/1 (yy/mm) (%) Current year (3-month moving average) Next year (3-month moving average) Note: Revision Index = (number of stocks revised upward number of stocks revised downward) / number of revised stocks. Source: Made by MHRI based upon IBES (yy) 2

22 6. Forex market trends: the topside of the USD/JPY exchange rate should remain heavy The USD/JPY exchange rate: the topside of the dollar should remain heavy amid the deterioration of risk sentiment reflecting global uncertainties. The EUR/USD exchange rate is continuing to fall, reflecting Italy s fiscal problems in addition to the deterioration of business confidence. Turning to the USD/JPY exchange rate, while the FRB s stance of gradual rate hikes should serve as support for a weak yen, the topside of the dollar should remain heavy for some time. Given the ongoing adjustment of stocks and crude oil prices, it should take a while for investor sentiment to improve. The EUR/USD exchange rate: there are concerns regarding a further fall of the euro amid worries regarding peripheral countries and a possible delay in the ECB s monetary policy normalization. [ USD/JPY exchange rate and Japan-US 1yr government bond yield spread ] [ EUR/USD exchange rate and Eurozone PMI ] (JPY) USD/JPY (%Pt) Japan-US 1yr government bond yield spread (rhs) (USD/EUR) EUR/USD Eurozone PMI (comprehensive; right axis) (Pt) /7 18/8 18/9 18/1 18/11 (yy/mm) Source: Made by MHRI based upon Bloomberg 1.5 Source: Made by MHRI based upon Bloomberg 5 (yy/mm) 21

23 8. Outlook on the financial markets US Japan Europe Forex FF rate (qtr-end value, %) 1yr UST bond yield (%) Dow Jones Average (USD) Euroyen TIBOR (three months, %) 1yr JGB yield (%) Nikkei 225 Average (JPY) ECB repo rate (qtr-end value, %) 1yr government bond yield (German bonds, %) USD/JPY exchange rate (JPY/USD) USD/EUR exchange rate (USD/EUR) Main scenario Sub-scenario 1 Sub-scenario 2 218/ / 219/ 218/ 219 Jul-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep Oct-Dec Jan-Mar Apr-Jun Jul-Sep , , , , , , , , , , , , , , , , , , , , , , , , , , Sub-scenario 1 (upside scenario) Long-term interest rates and stocks rise on heightened interest rate hike expectations driven by the acceleration of US economic recovery. The dollar continues to strengthen against the yen. Sub-scenario 2 (downside scenario) Global economic slowdown, including Europe and the US, due to tariff hikes accompanying US protectionism policy. Long-term interest rates fall and stock prices fall. The dollar continues to weaken against the yen. 22

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