Global Macro: Japanese Inflation Shows Policy Is on Track

NEW YORK (TheStreet) -- Japan's unprecedented monetary stimulus has pushed the yen to record lows while the Nikkei index continues to trend higher.

Prime Minister Shinzo Abe's plan to aggressively spend Japan out of its deflationary cycle seems to be working so far. Japan's core CPI number, released Thursday, was 1.2%, which outperformed expectations of 1.1% This means that inflation has surpassed the halfway point of the Bank of Japan's 2% target.

Over the past few months Abe has worked with unions to get an increase in labor pay at the next round of wage negotiations. Increased wages will justify the growth of inflation since the aggressive policy was put in place. The additional cash in consumers' pockets will work in a cyclical fashion, improving spending, which in turn will lead to improved corporate profits.

A major criticism of higher inflation to this point is that it is due primarily to the yen's weakness. The artificial weakening of the currency by the Bank of Japan has made its exports less expensive vs. its foreign competitors.

This had led to improved manufacturing sentiment and GDP growth, but domestic issues such as increased wages must grow for the recovery to be sustainable.

The weakening of the yen has also been a product of weak Japanese monetary policy compared with other central banks across the world. In December the Federal Reserve chose to taper stimulus which led to a spike higher in the U.S. dollar over the yen.

U.S. data since the tapering has been surprisingly strong. Employment numbers have been on the rise, while more jobs are coming available across the country. Both investors and corporations are buying into the labor market recovery, which should bode well for U.S. dollar strength in 2014.

The yen's outlook in the new year is for the currency to head lower as justified by evidence presented above. Inflation should also continue its trend towards the Bank of Japan's 2% target.

This means that the Nikkei equity index, which trades inversely to the direction of the yen, should continue to push higher in 2014.

If Japanese corporate results improve and economic growth remains stable, then 2014 could be a very strong year for the Japanese economy.

FXY Chart

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CurrencyShares Japanese Yen Trust (FXY)

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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