(30 January 2020)DAILY MARKET BRIEF 2:Bank of Japan may stay dovish for longer

And with the manufacturing and non-manufacturing PMIs dropping below 50, we expect the weakness to continue in 1Q20.

Fallout from the coronavirus could also weigh on growth in 1Q, stemming from the decrease in tourism (30% of foreign tourists come from China), some yen appreciation and supply chain disruptions (to Japanese auto and electronic machinery makers that operate in China). The market foresees a short-term drag of 0.1–0.3 percentage points to Japan's GDP q/q growth in 1Q. But we expect the economy to start recovering visibly 2H20.

Although the weakness may continue for longer, December export data provided early signs of a recovery ahead. Most notably, despite a soft headline figure, exports of electronic parts/devices accelerated by 6.5% y/y and semiconductor equipment surged by 30.6% y/y. Core machinery orders, which are a leading indicator of capex by 2–3 quarters, also rose 0.6% m/m, after falling for three straight months.

BoJ may stay dovish for longer

The Abe administration nominated Seiji Adachi, a market economist and well-known reflationist, as a new Bank of Japan (BoJ) board member. If approved by the Diet, he would replace Yutaka Harada, whose term will end on 25 March. Although Adachi's joining might not have a meaningful impact in the near future, the nomination of another reflationist could reflect Prime Minister Shinzo Abe's aim to keep the current monetary policy regime for longer.

The BoJ's dovish stance and the easing of US-China trade relations should limit the downside for USDJPY in 1H20. Still, we maintain a downward bias given our anticipation of broad dollar weakness. For the equity market, moderate earnings growth (3%–4% in FY20–21) and expensive valuations versus longer-term averages favor high-quality stocks that pay high dividends. Japanese government bond rates will likely stay near zero and remain unattractive for investors.

By UBS