It’s probably not the time to say this, given Tuesday’s sharp sell-off, but are some financial markets overreacting to the Japanese earthquake?
An annual standard deviation for the Nikkei in just three days! For Nomura’s Owen Job, that seems to be an out sized and over-the-top reaction.
Assessments of the economic impact of the earthquake in Japan vary, but at just over $100bn this would be similar to the cost of Hurricane Katrina to the US. The S&P declined 5% in response to Katrina, but later rebounded 10%. The Nikkei is currently down nearly 20%.
Another major market repricing after earthquake has been the decline in US 2yr rates across major curves, down 16bp, 22bp and 15bp across USD, GBP and EUR curves, respectively (adding to the 16bp and 10bp declines in US and UK 2yr rates since the escalation of the MENA crisis). This is not a rational and data-based repricing, in our view. US economic data has been strong, and the major contagion channel for both crises is likely to be through energy costs. A rise in energy costs is ambiguous for monetary policy – it could simultaneously add to downside growth risks and upside inflation risks.
And yet given the likely reassessment of nuclear power round the globe, oil and natural gas prices are down from their pre-quake levels. Explain that. Or the fact that shares in BP were down nearly 6 per cent at pixel time. Or this.
RTRS-ICE BRENT CRUDE FUTURES <LCOc1> FALL $3 TO $110.67 A BARREL
Job reckons that’s because investors are now worried about slowing global growth.
A back of the envelope calculation suggests that if Japan were to switch all its nuclear power generation to oil-fuelled power stations (assuming it has the capacity) this would add approximately 0.5 m bbl/day to global oil demand. The greater concern, in our opinion, should be that this leads to a wider reassessment of the viability of nuclear power across the globe. Concerns certainly exist as discussions in several countries, Germany and India to name two, illustrate. Anti-nuclear campaigners will presumably look to use this incident to argue for the slowing of global nuclear power use.
However, Liu Tienan, the head of National Energy Administration in China, signalled his continued approval for nuclear power. China is the world’s fastest expanding user of nuclear power, and intends to add 40GW of new nuclear capacity in the next five years. Interestingly, despite the focus on this issue in headlines, oil and natural gas prices are down since before the earthquake, implying expectations of a decline in global growth and hence energy demand combined with market repositioning are currently trumping the possible increase in oil demand from a reversal in the expanding use of nuclear power.
But how likely is that?
Not very, says Citi strategist Jonathan Stubbs.
At the equity market level we do not expect the earthquake materially to impact the key drivers to the world economic recovery or investors’ risk appetite. Here the growth in EM and the US remains the most important macro driver and a negative shock for the Japanese economy is unlikely to be enough to push the world economy back into recession. Furthermore, at the margin the policy makers in the world are more likely to maintain cheap money to keep recovery on track to counteract any negative impact from Japan. Cheap money should be supportive to equity markets.
Of course, the counter point to those arguments is China syndrome. This idea, advanced by BNP Paribas, is that there could be very grave consequences for Chinese GDP if supply chains between the two countries are severed.
And it’s worth noting that companies like Honda have suspended all production in Japan partly because of power shortages but also because they can’t get parts from their suppliers.
Indeed, the supply chain thesis does seem to be gaining some traction in the market. This just in from RBS.
Beyond capital market disruption, there are 2 principal real economy links between Japan & rest of Asia to consider. 1) Trade: ex Indonesia & Philippines, the other major Asian countries run a trade deficit with Japan, ie they import more than they export. Japan is c9% of Asia exports, vs 12% for each of Europe & US. By contrast, Asia has a bigger dependency on imports from Japan, particularly higher value added products in the Asia manufacturing supply chain. This makes a potential supply shock impact on inflation a potentially very uncomfortable outcome for Asia – particularly given that high inflation is already a major concern across the region. 2) Foreign Direct Investment from Japan into Asia is low as a proportion of GDP, at <0.5%. But, this misses the point that FDI in Asia is currently low & is expected to rise as a key driver of growth in future years. Japan typically accounts for c10% FDI into Asia, and is as high as 25-30% in Taiwan & Indonesia. Taken together, these could influence both the speed & scale of interest rate rises across Asia, and potentially the pace of future real GDP growth.
Still the market looks to go have got one thing right.
Presenting (via Markit) the CDS price of Tokyo Electric Power Company.