Kozo Koide: Jackson Hole

Arranged for Global Interdependence Center Program in Jackson Hole

July 12th , 2013

Recent development of Japanese Economy & its implication for investment ～ What is happening by ABENOMICS? ～

Kozo Koide Chief Economist DIAM Co.,Ltd

Comment on ABENOMIX

Nikkei & Yen after the Election in Nov. ’12

Sharp rise of equity price associated with depreciation of the yen

円/＄

< Nikkei 225>

yen

16000

Chairman Barnanke's testimonyat Congress (5/22)

15000

< Yen / $ Rate >

105

Chairman Barnanke's testimony at Congress (5/22)

100

Policy meeting of BOJ (4/4)

14000

95

Policymeeting of BOJ (4/4)

13000

Sharp rise of interbank rate in China (6/6)

12000 11000

Sharp rise of interbank rate in China (6/6)

90 85

10000

Source: Bloomberg

1

DIAM Economic Research

Sourse：Bloomberg

Kozo Koide, Chief Economist DIAM

13.06.27

13.05.28

13.04.28

13.03.29

13.02.27

13.01.28

12.12.29

12.11.29

12.10.30

12.09.30

12.08.31

12.08.01

75 13.06.27

13.05.28

13.04.28

13.03.29

13.02.27

13.01.28

12.12.29

12.11.29

12.10.30

12.09.30

12.08.31

12.08.01

8000

Dissolution of the House of representatives(11/16）

80

Dissolution of the House of representatives(11/16）

9000

DIAM Economic Research

Comment on ABENOMIX

ABENOMICS : Three Arrows

Bold monetary policy, Flexible fiscal spending, & Growth strategy – 1. Bold monetary policy » BOJ launched inflation target at 2% at the latest policy meeting (1/22) with open-end asset purchase program. Issued joint announcement with government. » Assign new BOJ Governor & Deputy Governor to facilitate bolder QE. Double the monetary base in two years.

– 2. Flexible fiscal spending » Government launched 13.1 Tyen supplemental budget, 2nd largest in the past. (1/15)

– 3. Growth strategy » Launched toward June and followed by 2nd package after upper house election 1. For cap-ex : tax incentives for cap-ex, R&D etc 2. For employment : deregulation in nursery case stations etc 3. For new markets : establishing NIH etc » Underestimation is risky (tax code change in the middle of the year, etc) 2

Kozo Koide, Chief Economist DIAM

Comment on ABENOMIX

Weakened Credit Multiplier Effect

Source:BOJ

DIAM Economic Research

3

*Bold Line：4Q Average

30 25 20 15 10 5

Source：FED,DOC,ECB,Eurostat,BOJ,Cabinet Office

Kozo Koide, Chief Economist DIAM

12.09

11.09

10.09

09.09

08.09

07.09

06.09

05.09

04.09

03.09

0 02.09

(Note)M2 : Connected the former data set using MoM change after S.A.

Japan

35

01.09

Credit Multilier(RHS)

Euro Zone

00.09

Monetary Base

US

99.09

13.5 13.0 12.5 12.0 11.5 11.0 10.5 10.0 9.5 9.0 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0

82.04 83.04 84.04 85.04 86.04 87.04 88.04 89.04 90.04 91.04 92.04 93.04 94.04 95.04 96.04 97.04 98.04 99.04 00.04 01.04 02.04 03.04 04.04 05.04 06.04 07.04 08.04 09.04 10.04 11.04 12.04 13.04

55 50 45 40 35 30 25 20 15 10 5 0 ▲5 ▲10 ▲15 ▲20 ▲25 ▲30

< Japan,US,Europe : Asset Size of Central Bank(to Nominal GDP) >

％

40

98.09

< Monerary Base & Credit Multiplier>

YoY (%)

97.09

Credit multiplier under the deflation has come down to very low level.

The size of BOJ’s B/S has been larger than that of US for long time.

96.09

DIAM Economic Research

Comment on ABENOMIX

Weakened Relation between Money & CPI

Under the deflation, growth of money has almost lost its effect on CPI. < M２ (YoY）・ CPI Core（ YoY） >

CPI Core （YoY ％） 9 8 7

３ MMA

1980/01～2013/2 1995/01～2013/5

6 5

y = 0.2671x - 0.2357

4 3 2 1 0 ▲1

y = 0.0304x - 0.154

▲2 ▲3 ▲2

M2(YoY%) ▲1

0

1

2

3

4

5

6

7

8

Source : BOJ, Ministry of Internal Affiairs & Communications

4

Kozo Koide, Chief Economist DIAM

9

10

11

12

13

DIAM Economic Research

14

Comment on ABENOMIX

Kuroda’s Shock : “Still Channels are Open”

Kuroda emphasized a room for additional easing effect under deflation – 1. Interest rate channel : to push down longer-term interest rate.

– 2. Portfolio rebalancing channel : facilitate reallocate assets to riskier markets – 3. Expectation channel : boost inflation expectation in markets, households & corporations. Governor Kuroda emphasize this channel in particular. » Aggressive QE with clear cut commitment of BOJ will change the expectations. » Not proved authentic theory to argue direct causality from QE to expectation in TIPS markets. Now leading studies have been appearing but the outcomes are diversified. Woodford(2010), Thornton(2012), Hoffman & Zhu(2013) 5

Kozo Koide, Chief Economist DIAM

Comment on ABENOMIX

JGB : Higher Long-term Rate

JGB yield has gone up with bear flattening after the easing – The purchase amount with shorter duration than 5 years was smaller than expected. Those for 5years to 10 years is more than expected.

– But it has been a bear flattening after US treasury market began to adjust.

– Real interest rate is more important for inflation targeting, though. ％

< JGB Yield Curve > 2012/12/28

1.0

2013/4/5

2013/6/28

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

1

2

Source： Bloomberg

6

3

4

5

6

7

8

9

10

Year DIAM Economic Resea rch Kozo Koide, Chief Economist DIAM

Comment on ABENOMIX

Portfolio Rebalance : Not Accelerated Much Bank lending has been growing faster but not be accelerated so much.

– Cash reserve at BOJ has been growing rapidly

< B/S of Domestic Banking A/C (3m total YTY contribution) >

%

5.0

100Mil yen

a: Bank total (After adjustments)

4.0

1,600,000 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 0 ▲200,000 ▲400,000 ▲600,000 ▲800,000 Gray Shadow: Recession ▲1,000,000

3.0 2.0 1.0 0.0 ▲1.0 ▲2.0

Source: BOJ

DIAM Economic Research

7

13.07

13.01

12.07

12.01

11.07

11.01

10.07

10.01

09.07

09.01

08.07

08.01

07.07

07.01

06.07

06.01

05.07

05.01

04.07

04.01

03.07

03.01

02.07

02.01

01.07

01.01

▲3.0

Other Assets

Inter Office Assets

Trading Assets

Lending

Cash + Call Loan

A/C Receivables

Other Securities

JGB

Securities

Foreign Securities

Total Assets

07.07 07.10 08.01 08.04 08.07 08.10 09.01 09.04 09.07 09.10 10.01 10.04 10.07 10.10 11.01 11.04 11.07 11.10 12.01 12.04 12.07 12.10 13.01 13.04

< Loans and Discounts (Average Amounts Outstanding, YoY) >

Source:BOJ

Kozo Koide, Chief Economist DIAM

DIAM Economic Research

Comment on ABENOMIX

Portfolio Rebalance by House Holds

Deflation → Larger cash & lower equity. It should change in inflation – Large drop from in cash and deposit markets in the Jan.-Mar. Q in 2013.

– The share of domestic equity in the total financial assets held by house holds (1570 trillion yen, about 15.5 trillion $) has bottomed in Oct.-Dec. Q in 2011. ％ 16

< Households : Share of Cash & Deposits in Financial Assets >

％ 57

< Share of Domestic Equity in Households' Financial Assets >

9 Share of Domestic Equity（4QMA） CPI（Core)（YoY,RHS）

15 14

56

（Note) Domestic Euity is inclusive of those in investment trust held by households

13 55

％

12

8 7 6 5

11

4

53

10

3

9

2

8

1

7

0

50

6

▲1

49

5

▲2

4

▲3

52 51

Source : BOJ

8

13.03

12.06

11.09

10.12

10.03

09.06

08.09

07.12

07.03

06.06

05.09

04.12

04.03

03.06

02.09

01.12

01.03

00.06

99.09

98.12

98.03

48

DIAM Economic Research

80.03 81.06 82.09 83.12 85.03 86.06 87.09 88.12 90.03 91.06 92.09 93.12 95.03 96.06 97.09 98.12 00.03 01.06 02.09 03.12 05.03 06.06 07.09 08.12 10.03 11.06 12.09

54

Source : BOJ, Ministry of Internal Affairs & Communications

Kozo Koide, Chief Economist DIAM

DIAM Economic Research

Comment on ABENOMIX

Inflation Expectation : Picked Up Already D.I. of expected inflation by households & corporations are picking up

– Though causality directly from monetary base to expected inflation by households and corporations are seemed to be weak, they have already been picking up.

– Besides the economic recovery with the progress in inventory adjustment together with the correction of too high yen and the rise of stock price. %pt

< CPI (core)・ Expected Inflation D.I. Of Households >

%pt 110 100 90 80 70 60 50 40 30 20 10 0 10 ▲ ▲20

％ 2.5

Change from field interview to mail survey after 2013/3.Connect simply.

2.0 1.5 1.0 0.5

30

< PPI ・ Expected Sales Price D.I. of Corporations >

20 10 0 ▲10

0.0

▲1.5 ▲2.0

Source ： Cabinet Office,Ministry of Internal Affairs & Communications

9

13.04

12.10

12.04

11.10

11.04

10.10

10.04

09.10

▲2.5 ▲3.0 09.04

08.10

08.04

07.10

07.04

06.10

06.04

05.10

05.04

04.10

04.04

Expected Inflation D.I. Core CPI（ YoY,Right Scale)

DIAM Economic Research

▲20 ▲30 ▲40 Expected Sales Perice D.I. (Large Manufacturing),RHS PPI(domestic final goods excluding consumption tax)

▲50 ▲60

9 8 7 6 5 4 3 2 1 0 ▲1 ▲2 ▲3 ▲4 ▲5 ▲6 ▲7 ▲8 ▲9 ▲10

86.03 87.03 88.03 89.03 90.03 91.03 92.03 93.03 94.03 95.03 96.03 97.03 98.03 99.03 00.03 01.03 02.03 03.03 04.03 05.03 06.03 07.03 08.03 09.03 10.03 11.03 12.03 13.03

▲0.5 ▲1.0

％

Source : BOJ

Kozo Koide, Chief Economist DIAM

DIAM Economic Research

Comment on ABENOMIX

Forecast of Inflation : Not Easy for 2% Estimation of CPI (core) YoY at Mar. ’15 is around 1.5% – But based upon the past economic structure under deflation.

– Focal points are wage, yen rate besides inflation expectation.

< CPI(core) YoY Forecast >

％

Demand-Supply Gap Foreign exchange Inertia

2.5 2.0

Inflation expectation Old price Estimation

wage Rent

1.5 1.0 0.5 0.0 ▲0.5 ▲1.0 ▲1.5

10

Kozo Koide, Chief Economist DIAM

14.12

14.06

13.06

12.12

12.06

11.12

11.06

10.12

10.06

09.12

09.06

08.12

08.06

Source : Ministry of Internal Affairs & Communications, Cabinet Office, Misitry of Health, Labor & Welfare、Datastream

13.12

E

▲2.0 07.12

DIAM Economic Research

Comment on ABENOMIX

Depreciation of Yen Would Roll On

The interest differentials between US & Japan will expand.

– Recently the sensitivity of yen rate against real expected interest rate differentials has been elevated. (since ’12/8 adjusted R2 = 0.98, T-value = 20.6) – Current account surplus has been dramatically shrunk. < Yen/$ Rate & Real Expected Interest Rate Differentials>

102 100 98 96 94 92 90 88 86 84 82 80 78 76

%

< Current A/C of Japan & $/YEN Rate >

log10

0.0

yen/$ rate

▲0.1

Real Expected Interest Rate differentials (5ys) RHS

▲0.2

$/YEN Rate JPN:Current Account / Nominal GDP (4QTotal %, 1Y leading RHS)

2.20

0.5 1.0

2.15

1.5

▲0.3 2.10

2.0

▲0.4

2.5

▲0.5

2.05

▲0.6

2.00

3.5

▲0.7

1.95

4.0

3.0

4.5

▲0.8 1.90

5.0

▲0.9

Source : BOJ, Bloomberg

11

DIAM Economic Research

5.5

Source : BoJ

Kozo Koide, Chief Economist DIAM

13.09

11.09

09.09

07.09

05.09

03.09

01.09

99.09

97.09

95.09

93.09

91.09

89.09

1.85 87.09

13.06

13.05

13.04

13.03

13.02

13.01

12.12

12.11

12.10

12.08

▲1.0 12.09

yen/$

DIAM Economic Research

Comment on ABENOMIX

Currency War !? : Unfair to Criticize Japan No currency intervention, Distorted appreciation for years – Basically under the floating exchange regime, Japan has autonomy in monetary policy.

– CF: PPP for GDP (OECD) in 2012: » Japan: 103.90 (yen/$) 30.2% higher. Germany: 0.799(€/$）2.7%higher, Korea: 815.93(KW/$) ▲27.6％cheaper ％

< Diviation of FX Rate from PPP>

100

Japan

Germany

Korea

80 60 40 20 0 ▲20 ▲40

2011

2009

2007

DIAM Economic Research

Source : OECD, Datastream

12

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

▲60 1985

Kozo Koide, Chief Economist DIAM

Comment on ABENOMIX

Deflation Pressure from China, Eased Unit labor cost in China continue to soar, while Japanese stay stable.

– The import from China has not so deeply discounted recently. ％

< CPI (weighted by the import from China) (YoY)・ China Unit Labor Cost (Mfg.) in yen (YoY) >

(note) ULC = Wage (manufacturing) / IIP, IIP for 1Q is the average of previous Q and next Q, Yen Base CPI of items w hich are matched w ith the components of imports from China. Weighted average by the value as of 2005CY.

0

50

CPI

ULC of Manufacturing industry in China in yen (4Qma,RHS)

45 40

▲5

35 30

▲10

25 20 ▲15

15 10

▲20

5 0

Source: MOF, Ministry of Internal Affairs and Communications,NBS

13

Kozo Koide, Chief Economist DIAM

13.06

12.12

12.06

11.12

11.06

10.12

10.06

09.12

09.06

08.12

08.06

07.12

▲5 07.06

▲25 06.12

DIAM Economic Research

Comment on ABENOMIX

Wage Increase : Macro Change w/ Policy

Non-structural unemployment is decreasing, Expected tax incentives – There has been a “normative” wage cut after the change of labor law in 2004, which invite more flexible employment of temporally staff.

– If the progress in labor productivity would be transferred to household more fairly supported by policy incentives, the wage growth would become sustainable.

％

< Hourly Wage (YoY) Estimation >

7

Estimation(dotted line :±σ） Real data(after 12MMA)

6

< Wage Index (Nominal / Real) YoY >

％

3.0

6mma

2.0

5

1.0

4

Major change in Temporary Staffing Services Law (2004/3)

3

0.0 ▲1.0

2 ▲2.0

1 ▲3.0

0

▲4.0

Source : Ministry of Health, Labor & Welfare

14

Real

DIAM Economic Research Source:MHLW

Kozo Koide, Chief Economist DIAM

DIAM Economic Research

13.01

12.07

12.01

11.07

11.01

10.07

10.01

09.07

09.01

08.07

08.01

07.07

07.01

06.07

06.01

05.07

05.01

04.07

04.01

03.07

03.01

02.07

01.07

01.01

00.07

Establishm ent with 30 or m ore em ployees 00.01

13.01

12.01

11.01

▲6.0

10.01

09.01

08.01

07.01

06.01

05.01

04.01

03.01

02.01

01.01

00.01

99.01

98.01

97.01

96.01

95.01

94.01

93.01

92.01

91.01

（Note）OLS estimation by the unemployment due to the lack of demand, period : 1990- 2004/2

90.01

▲3

Nominal

▲5.0

▲2

02.01

▲1

Views on Tokyo Equity Market

NIKKEI : Depends on the Exit from Deflation Deflation → NIKKEI’s sensitivity to corporate profits lowered – Now, almost a mirror of JGB yield. Even so, the higher target at the end of ’12 was about 12400. Current surge is not a bubble, no excess liquidity is taken into account.

– What if deflation is over? Levered with cap-ex for higher total factor productivity. Higher sensitivity to corporate profits, 18700 as of the last year-end < N I K K E I2 2 5 : E s t im a ti o n > N ikke i225 E st. 3 (b y c o r p o r a te p r o fi ts & J B G y i e l d , fr o m '9 5 ) E st. 2 (b y c o r p o r a te p r o fi ts, J G B y i e l d , e x c e ss l i q u i d i ty , i n '8 0 s) E st. 1 (b y c o r p o r a te p r o fi ts, J G B y i e l d , fr o m '8 0 -'8 4 ）

4 0 ,0 0 0 3 5 ,0 0 0

W h a t H a ppe n e d? ?

3 0 ,0 0 0 2 5 ,0 0 0 2 0 ,0 0 0 1 5 ,0 0 0 1 0 ,0 0 0 5 ,0 0 0

( N o te ) N ikke i2 2 5 f o r '1 3 /1 - 3 Q is th e a v e r a g e f r o m '1 3 /1 - '1 3 /2 /1 4

15

S o u rc e : D a ta s tre a m , M o F , B o J

12.12

10.12

08.12

06.12

04.12

02.12

00.12

98.12

96.12

94.12

92.12

90.12

88.12

86.12

84.12

82.12

0 80.12

D IA M E c o n o m i c R e se a r c h

Kozo Koide, Chief Economist DIAM

Views on QE Global Markets

Concerted QE : Uncharted at the Exit QE : Tend to lower the volatility. What would happen in the future?

– Now we are facing the exit policy taken by the Fed. – BoJ’s recent move add volatility both in Nikkei and JGB. The other way around?

– Watching at common factor of the moves in different markets, Japanese markets may have been started to act as an odd ball, good or bad. (← prime factor loading)

Source：Bloomberg

16

Source：Bloomberg

Kozo Koide, Chief Economist DIAM

+ Kuroda's QE 13/5

13/2

12/11

12/8

12/5

12/2

11/11

11/8

11/5

11/2

07/2

13/5

13/2

12/8

12/11

12/5

12/2

11/8

11/5

11/2

11/11

DIAM Economic Research

10/11

（Note）Volatility : Histrical DoD volatility in 25 days

0.0

10/11

10/8

10/5

10/2

09/11

09/8

09/5

09/2

08/8

08/11

08/5

08/2

07/8

07/11

07/2

07/5

（Note）Volatility : Histrical DoD volatility in 25 days

10/8

0.2

10/5

1.0

10/2

0.4

09/11

2.0

09/8

0.6

09/5

3.0

0.0

+QE3

0.8

09/2

4.0

LTRO

Japan

1.0

08/11

5.0

QE2

Germany

1.2

08/8

DAX Nikkei 225

QE1

US

08/5

LTRO +QE3

08/2

QE2

07/8

6.0

QE1

07/5

NY Dow

< Volatility of 10ys Government Bond (DoD) >

1.4

+ Kuroda's QE

7.0

％

07/11

< Volatility of Equity Price (DoD) >

％

DIAM Economic Research

Disclaimer

This documentation was prepared independently by DIAM Co., Ltd. and is not required pursuant to the Financial Instruments and Exchange Law. This documentation is required to be used only by the investor to whom it is distributed.

This documentation is only for the purpose of providing information and is not intended to be used to solicit investments.

This documentation was prepared using data that DIAM Co., Ltd. has judged to be reliable. However, DIAM Co., Ltd. does not guarantee its completeness or accuracy. Additionally, the published data are only indicative of past performance and do not provide a guarantee of future performance.

The contents included in this documentation are only current as of the date this documentation was prepared (July 9th, 2013) and are subject to change without notice.

The intellectual property and all other rights pertaining to the data published in this documentation including benchmark indices shall remain the property of the publisher and licensor.

17

Kozo Koide, Chief Economist DIAM