Japan's LEI Waffles and Slows

Japan's leading economic index in June slipped to 100.6 from a level of 101.2 in May. May, in turn, had slipped from a level of 102.9 in April.

The leading economic index, which is an index that tries to look at currently available economic data and assess what it means for future economic performance, declined at a 0.8% annual rate over three months, at a 4.4% annual rate over six months and at a 2.8% annual rate over 12 months. However, because of the timing of the pandemic, over a 24-month period, the index is up at a 21.5% annual rate.

Clearly Japan is solidly in the recovery from COVID; however, it's not continuing to make much headway anymore. The sequential annualized growth rates reported above and presented in the table paint a picture of continuous slowing ahead, although the trend for the slowdown does not have a steady profile. There is a significant decline over 12 months, which worsens over six months, and then shows less distress over three months. On balance, Japan's economy is waffling and continues to get weaker; it has weakened in each of the last two months. This, in part, is because of a tougher comparison with April; in April, the leading economic index moved up to 102.9 from a level of 100.8 in March marking its highest point since December. The LEI index was last higher than its April 2022 level last in July 2021.

When the leading economic index lurches like it has been doing, its signal is less useful to markets and to policymakers.

Consumer confidence The components of the leading economic index are available as of May. They lag by one month; however, there is a related topical economic statistic that also available through June: that is the reading on consumer confidence.

Consumer confidence rose in May compared to April rising to a level of 32.9 from a level of 32, but in June it was set back to 32.2. Consumer confidence has a net gain from April over three months it's falling at a 6% annual rate; falling at a 31.5% annual rate over six months; over 12 months it's falling at a 14.4% annual rate. Like the leading index, consumer confidence is declining over 12 months, the decline speeds up over six-months, then it slows down over three months. These two indexes that draw from diverse kinds of economic data but obviously are linked to the economy suggests that there has been some widespread slowdown that subsequently dissipated. This common pattern is not simply random variability.

LEI components On a lagged basis, the inputs for the Japanese leading economic index show consistent positive changes from the interest rate spread. Loan and deposit changes are also positive although they've slowed. Starts for dwellings have positive changes over six and 12 months but a small net decline over three months. Deliveries and stockpile show month-to-month changes that are positive indicating consistent economic pressures and desires to rebuild stocks. These signals are consistent with growth. However, these metrics, while positive, have slowed on horizons of 12-months, to six-months to three-months. Export growth continues to exceed import growth in the LEI framework and there's no clear trend in that pattern.

Growth in Japan- the yen Japan has been struggling for some time; it has a lower inflation rate than most other industrialized countries and doesn't really have an inflation problem although the inflation that it has acquired is the undesired variety. Japan's currency has been falling rather rapidly particularly against the dollar and that is a double-edged sword; while it increases the competitiveness of production that is going on in Japan, it increases the cost of inputs and that hits the oil bill particularly hard which is a big bill in the wake of the Fukushima nuclear disaster. After that, Japan shut down most nuclear facilities. Japan is taking some steps to maintain and possibly reactivate some of its nuclear reactors in the face of incredibly high global oil prices, made worse by a weakening yen.

Other international factors While the exchange rate is moving in a direction that might help Japan with competitiveness, China, its most important trading partner, continues to wrestle with its policy of zero COVID. That continues to create lockdowns which interrupt and slow growth. This has deleterious effects on Japanese economic activity. Japan's second-largest trade partner is the United States, a country that posted negative GDP growth in both the first and second quarter. Although U.S. consumer spending continues to be relatively firm and job growth has continued to hold up even as the Federal Reserve has raised interest rates relatively sharply.

The outlook for growth in Japan is still unclear. The economy is growing slowly, and it faces challenges. It's most important trading partners have their own separate issues and, of course, with the new heating up of the geopolitical environment over Taiwan there's no telling if that will develop as a negative influence for Japan or not. Covid continues to be an issue. The war in Ukraine and the various impacts of sanctions continue to be issues. And like every other country, Japan continues to trade in a global environment where most other large central banks are raising interest rates, trying to gain control of inflation and to slow growth. This is not the easiest environment in which to stimulate economic growth, but that remains as Japan's key policy goal.