Inflation in Japan has been on the rise, reaching unprecedented levels with core inflation staying above 3% annually for the past year. The possibility of monetary tightening by the Bank of Japan (BOJ) caused speculation in the market. BOJ Governor Kazuo Ueda hinted at a potential increase in the prime interest rate of -0.1% during a press interview three weeks ago, leading to a small rally in the yen. However, during a Sept. 21 policy meeting, the bank decided to maintain the current interest rate due to “extremely high uncertainties.” This led to the yen tumbling towards a record low of 150 to the dollar.
The current exchange rate is significant as it is the level where the BOJ intervened last fall. In combination with slumping U.S. Treasury yields, the yen appreciated by 17% within a three-month period. This time, Governor Ueda and his colleagues are adopting a wait-and-see approach, anticipating wage hikes resulting from negotiations next spring. Masamichi Adachi, the chief Japan economist at UBS, believes they still view inflation as temporary, stating that “the economy is not overheating yet.”
While a weakening currency typically has a negative impact on equities, this is not necessarily the case for Japan’s market. Exporters like Toyota Motor, Sony Group, and Keyence dominate the market. These companies have experienced significant growth due to a combination of a depreciating yen and stronger-than-expected demand from the United States and Europe. The iShares MSCI Japan exchange-traded fund (EWJ) has surged by 22% over the past 12 months, outpacing the 16% increase in the S&P 500.
According to Daniel Hurley, a portfolio specialist for international equities at T. Rowe Price, more gains are expected as long as the U.S. economy continues to perform well. He highlights that “half the revenue for listed Japanese companies comes from outside Japan,” which positions the market favorably.
The Bright Side of Japan’s Macroeconomic Situation
According to Aaron Hurd, the senior currency portfolio manager at State Street Global Advisors, Japan has found itself in a favorable macroeconomic position. Despite a record-low yen, the falling prices of most import commodities (excluding oil) have eased the impact. Prime Minister Fumio Kishida’s government plans to subsidize consumer fuel costs by taking advantage of borrowing rates below 1% per annum.
A potential recession in the U.S. may dampen Japanese exports; however, it could also lead to Federal Reserve rate cuts that would strengthen the yen. Hurd suggests that the yen could become the best-performing currency in the G10 next year, possibly reaching a rate of 155 to 158 against the dollar.
Investors are appreciating Japan’s initiatives to make companies more shareholder- and inflation-friendly. The Tokyo Stock Exchange has implemented sanctions on companies whose market capitalization falls below their book value. This move has been influential in Toyota’s remarkable 50% year-to-date surge. Additionally, Prime Minister Kishida is spearheading a program for “new capitalism,” which involves a 4% increase in the minimum wage and measures to facilitate flexible working arrangements.
Katrina Dudley, a portfolio manager at Franklin Templeton, expresses confidence in Japan’s potential for positive change, stating that “this time is different in Japan.” As a result, their exposure to Japan has increased.
On the other hand, some market players, like BOJ Gov. Ueda, are waiting for further data before making any decisions. Cameron Brandt, the chief of research at financial flows monitor EPFR, notes that professional money managers are now practicing caution due to past disappointments.
Nevertheless, Japan’s economy is undoubtedly moving in the right direction. While China’s economy struggles and poses political threats, Japan’s progress is good news.