Japan's Nikkei witnessed its biggest fall in two years when it closed 7.3 percent lower on Thursday. Richard Gibbs, global head, Macquaire Securities believes that unless there are necessary structural reforms. Japan would be heading towards a very inflationary environment.
He added that the new-found strength in dollar maybe adding to the nervousness in the equity markets too. He is wary of Bank of Japan's asset purchases of USD 75 billion a month.
Below is the edited transcript of his interview on CNBC-TV18
Q: It looks like there is complete chaos in the Japanese market. What is happening there and what has caused this big tailspin for equities and bond markets?
A: Real concern is that the Japanese are on the verge of fueling a major inflationary surge if we do not see very radical and necessary structural reforms coming through as part of this three-pronged approach to reflate the Japanese economy by Prime Minister Shinzo Abe. There is a lot of commentary in the last couple of weeks that if those structural reforms are not forthcoming then Japan really is fostering a very inflationary environment.
Q: This talk has been on for the last 10 days. What has led to the sudden 6 percent collapse in equities or the Japanese stock markets intraday? Do you think it could have anything to do with apprehension that because of the issue that you alluded to, the Japanese central bank too might consider clamping down on liquidity like we heard from the Fed minutes yesterday?
A: I think there seems to be a sea change around with central banks and there is this watching and waiting game going on with the Federal Reserve as you said about the winding back of QE3. When you look at the extent of impact in Japan from the Bank of Japan's (BOJ) activities; BOJ has been intervening and buying assets to the extent of USD 75 billion a month, that compared to an economy that is two-thirds greater in size in terms of the US buying at the rate of USD 85 billion a month.
So the quantum is a concern and if there is any kind of a wind back, then that takes enormous amount of the liquidity out of the markets. Bear in mind for last 20 years, the Japanese stock market has been an extremely volatile place to be in.
Q: There has also been an extremely sharp reaction in the currency market and overnight people have been talking about the prospect of the dollar getting stronger and many currencies falling lower. Is that, in part, playing with the kind of nervousness we are seeing in equity markets as well?
A: It certainly is. For most exchange rates which have seen substantial movement against the US dollar in the last 12-18 months, 70 percent of that effect has been directly attributable to QE activities of the Federal Reserve. When the Federal Reserve starts communicating I suppose a broad framework for its exit strategy from QE, it is really no surprise that the first incident of that will be felt in the foreign exchange market.
Q: Is there any apprehension that some things might be in a state of flux or could be beginning to change, because till yesterday the view was global markets are on a higher growth path, liquidity is abundant and therefore asset classes should not correct too much. This morning with what you are hearing from Japan, US, with the very poor PMI data from China, do you think we are about to hit some bout of volatility again?
A: I think we are. At the moment the discussion I have been having with clients and investors over here is that global asset markets, particularly risk asset markets in terms of equities have been on a high. They have been buoyed by liquidity more than real economy activity. This is where this disconnect is now. When you start to talk about taking away some of that liquidity and you do not have the strength in terms of real economic activity underneath it then obviously valuations in the equities market are going to be tested pretty considerably.