London is unbearable, with no air circulating and hot, humid weather. This is one of the reasons why markets always seem less comprehensible in July and August. One get depleted just being alive. Depleted people have a harder time making sense of things and make poorer decisions.

Is Mr. Abe a nationalist pushing an economic-reform agenda in order to get himself into a position where he can change Japan’s constitution, or does he really believe in Abenomics? These two are not mutually exclusive, and I suspect that the answer is “both”.

Reading some commentary yesterday, I was reminded of the question of whether the “Third Arrow” of Abenomics — structural reform — would be bold enough to have an effect. To answer this question, we need to think about what the effect could be. Structural reforms take ages to have a real effect: Tony Blair’s Britain benefited from Margaret Thatcher’s reforms; Angela Merkel’s Germany is benefiting from Gerhard Schröder’s; and so on. So the immediate question for the financial market is not whether structural reforms will be bold enough to have a real effect — their effect is years away — but whether they will look bold enough to keep inflation expectations, and thus the equity market, rising, and the currency falling (with what appear to be commensurate effects on global markets).

Let us make a first attempt to examine Mr. Abe’s incentives, assuming the LDP does well enough in the Upper House election on 21 July to control both houses, alone or in coalition.

Benefits of strong reforms:
Good personal legacy.
Long-term Japanese economic strength.

Costs of strong reforms:
Opposition from LDP vested interests could make the whole term difficult.

Mr. Abe is a nationalist — he wants to see Japan economically and politically strong. Thus, from his world-view, there is probably more to be gained from a strong third arrow than there is to be lost.

Let us drop the implicit assumption that there is a simple choice between a bold and a timid “Third Arrow”. Then the question is, how bold will it be? This will depend on how large the cost of opposition from vested interests would be. One assumes that, the more Mr. Abe is able to please his party by enacting his nationalistic agenda, the less it will play up over his economic agenda (taking the party as a single actor). Note that the LDP’s potential partner in the Upper House, New Komeito, is suspicious of the nationalistic agenda. Thus, the boldness of the “Third Arrow” will depend upon whether the LDP gains an absolute majority in the Upper House or requires a coalition.

What could be wrong with this model? The weakest point is the conception of the LDP as a single entity. Perhaps a major bloc will play up over economic reforms and does not care about the nationalistic agenda. I do not know enough about the party to know whether the assumption of singularity is reasonable or not.

Tim Duy observes that Ben Bernanke’s 7% threshold for the end of asset purchases was not in the Fed minutes, and that various Fed governors have given the impression that it is not the view of the FOMC. James Bullard even said that it was not clear that the FOMC would agree such a number. Mr. Duy argues that Bernanke has tipped his hand here: he has given away his own view, and how it diverges from that of his committee.

While we are on the subject of central-bank communication, a new blog called “ECB Watchers” argues that the ECB’s forward guidance suffers from the same fault as the Fed’s early version, inasmuch as it reads more like a statement of pessimism about the economy than a commitment to future action; it also argues that it would be better if there was a specific time period, or economic variable, given as the trigger for a rate increase. I am not quite as sceptical as the blog. I made these very objections in the summer of 2011 when the Fed first introduced its forward guidance: I thought it was a policy mistake, because it was nothing more than a statement of pessimism. But I was wrong: the markets did not interpret it that way. Rates declined and stayed low from the issuance of the initial form of forward guidance. On the other points, I would like to see a time-period specified; regular readers may recall that I think a time period is a superior form of forward guidance to a threshold based on some economic variable.

Ethanol RIN prices have run up extremely sharply in the US this year. The future was priced as an option at the start of the year, and I didn’t know anything about it! This just goes to show something I have often thought: it is worth regularly surveying the futures markets to see what is out there, and might be mispriced — particularly in markets where the government fixes the supply of the commodity concerned and where existing holders who bought low are unlikely to sell high (because they actually want to use the permits to keep their businesses open). Such markets have relatively inelastic supply, and therefore large price swings when demand changes.


  • US retail sales 0.4% d.e. June. Core 0% d.e. Looking at the levels and %YOY charts, it appears that retail sales growth slowed from the end of 2011. The last two months have seen something of a rebound in the YOY series, but growth is still slower than at that time.
  • Empire State 9.5 b.e. Jul.
  • Business inventories released. Inventory/sales ratio ticked down, but remained in the range it has been in since mid-2012.
  • Italy trade balance registered another strong surplus in May (EUR 3.9bn b.e., of which 0.9bn for EU area and 3bn for non-EU countries). YOY, exports were down 1.5% (-3.4% for EU area and +0.7% for non-EU countries) and imports were down 10.3% (-5.5% for EU area and -15.8% for non-EU countries). This is a reminder that the improvement in PIIGS current accounts has not been the result of “rebalancing” so much as such miserable recessions that imports have been hammered. Italy has had a trade deficit YTD with Germany, and an even larger one with the Netherlands. Its sales to France and the UK are the main reasons for its surplus with the EU; take out the UK, and it looks like there was a deficit with the Eurozone.