Trimming Japan on Yen Risk
The recent interest rate hike by the Bank of Japan (BoJ) is a pivotal moment in Japanese monetary policy, signifying a departure from years of negative interest rates and reflecting a structural transformation in the Japanese economy’s inflation dynamics. This decision contrasts sharply with the U.S. Federal Reserve’s stance, which maintained its policy but signaled an approaching end to the current rate plateau, anticipating rate cuts starting in June.
The BoJ’s rate hike, albeit modest at 10 basis points (lifting the benchmark rate to zero), marks the conclusion of an extended period of negative rates (“NIRP,” or “negative interest rate policy”), initiated in response to persistent, decades-long disinflation and anemic growth (which, we note, has not at all correlated with immiseration in Japan -- by all accounts, the country remains a very congenial place to live).
This action aligns with a broader reflationary trend in Japan, buoyed by a post-covid recovery in nominal GDP and a positive outlook on inflation and wage growth. The decision to raise rates dismantles the previous three-tier interest rate structure, signaling a cautious yet deliberate move towards normalization and a reluctance to revert to negative rates in future crises.
Significantly, the BoJ has also terminated its Yield Curve Control (YCC) policy and its commitment to expanding the monetary base through ETF and J-REIT purchases, although it will continue to purchase Japanese government bonds (JGBs) to control long-term volatility. This normalization process is intended to be gradual, and although the BoJ expressed a commitment to support ongoing reflation, further rate hikes are likely to be limited (which makes sense in the context of the BoJ’s massive bond holdings).
The narrative surrounding Japan’s economic outlook is one of structural change, with rising wages and service prices expected to sustain inflation above 2% in the first half of 2024. This shift is anticipated to influence long-term inflation expectations and consumer willingness to accept price increases. Additionally, a temporary income tax cut slated for June is likely to stimulate consumer spending further.
Despite these changes, Japan’s financial conditions remain supportive of growth, with corporate reforms, pricing power, and technological advancements fostering a positive economic cycle (as we have noted in recent letters). Japan’s companies are well positioned to benefit from efficiency gains spurred by AI. This environment on the face of it would underpin a bullish outlook for Japanese equities, particularly within the banking and asset management sectors, which stand to benefit from the transition to positive interest rates.
It took the Nikkei Index 44 years to reach new highs.
While we have seen about a 20% rally since we began to get more bullish on Japanese equities, we do suspect that the next 20% rally for Japanese stocks might be harder due to various factors and uncertainties that we discuss below. Some yen idiosyncracies make Japan’s equity performance harder to predict than if it merely depended on the performance of the economy and of Japanese companies.
The End of NIRP: What Effect on the Yen?`
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