Market Views: Will yen weakness continue to bolster Japanese equities?
The Japanese yen plumbed multi-decade lows this week while Japanese equities scaled fresh peaks, amid concerns over the Bank of Japan's (BOJ) policy stance.
The prolonged divergence in US-Japan rates amid rate cut delays fuelled yen’s recent slide past 160 against the dollar. It traded at 161 on Thursday after sinking to a 38-year low versus the greenback and a record trough against the euro a day earlier.
Currency interventions by Japanese authorities have proved in vain so far.
Conversely, Japanese stocks soared to an all-time high, with the Tokyo Price Index (TOPIX) closing at 2,898 points on Thursday, surpassing its bubble-era peak in December 1989, buoyed by a weakening yen. Nikkei 225 also hit a record high.
As the market scrutinised yen's trajectory and its impact on Japanese equities and economic growth, views diverged on whether a weaker currency would be a tailwind or headwind for the market.
AsianInvestor asked asset managers to assess yen’s path and its ramifications for investment strategies in Japan and the broader region as the debate intensified.
The following responses have been edited for brevity and clarity.
Sylvia Sheng, global multi-asset strategist
JP Morgan Asset Management
We maintain a neutral stance on the Japanese yen (JPY).
Despite its highly attractive valuation, the currency faces significant challenges due to negative carry. Although the nominal interest rate differential between the US and Japan has narrowed, the real yield differential remains substantial.
We anticipate the BOJ will implement a 15-basis point hike to 0.25% at the July Monetary Policy Meeting (MPM) and begin a gradual reduction in Japanese Government Bonds (JGBs) purchases from August onwards.
However, this gradual pace of monetary policy normalisation is unlikely to provide sufficient support for the JPY.
In our view, the only catalyst for JPY appreciation appears to be a more dovish stance from the US Federal Reserve than currently expected.
Additionally, the JPY faces headwinds from capital outflows driven by retail investments into foreign equities through Nippon Individual Savings Accounts (NISA) and a weaker trade balance due to higher energy import bills.
On the equity front, a range-bound yen should limit the second-order effects on Japanese equities, all else being equal.
However, at current levels, the risks to the yen are two-sided, which partly explains our recent downgrade of Japanese equities from positive to neutral, despite ongoing progress on corporate reform.
Significant yen appreciation would reduce earnings per share (EPS) growth due to the currency translation impact on overseas earnings, while significant yen depreciation could further pressure real wages and domestic demand.
Tomo Kinoshita, global market strategist, Japan
Invesco
I expect the Japanese yen to turn to an appreciation trend against the US dollar toward the end of this year, as I forecast two rate cuts by the Fed by the end of this year and one or two additional rate hikes by the BOJ toward the end-2024. Narrowing interest rate differential is likely to lead yen to appreciate beyond 150 yen/dollar at end-2024.
Impacts of weaker yen on Japan’s equity market have been positive for export-related stocks as it led to more export earnings in yen terms for exporters while yen depreciation affected negatively domestic demand-oriented stocks due to an increase in cost of imports.
Switching to the yen appreciation trend would change this picture since it would benefit domestic-demand oriented companies.
Over the coming months, I expect that a considerable rise in wages will lead to a moderate rise in Japan’s private consumption, which should benefit Japan’s domestic demand-related stocks as investors become more confident of Japan’s long-term growth on the back of virtuous cycle between wages and prices. A shift toward a stronger yen is expected to support this trend.
With these factors, I expect Japanese equities to modestly outperform US or European equities towards end-2024.
Masahiko Loo, senior fixed income strategist
State Street Global Advisors
Despite having a baseline view of yen appreciating to around 135 against the USD in the next 24 months, we think the currency will stay on the weaker side for now given it is more dependent on the US rate movement.
Options for Japan’s Ministry of Finance (MOF) are somewhat limited. They can only slow down the pace of yen depreciation and buy time for the Fed-BOJ policy compression into 2025.
The rapid pace of yen depreciation and limited MOF options leave the BOJ next in line to do the heavy lifting. We expect the BOJ to halve its current ¥6 trillion gross monthly bond purchases over the next two years, and potentially hike policy rate to 0.25% in July and reach the terminal rate of 0.75% or 1%.
These steps will put JGBs curve under bear flattening pressure in the near term. We forecast gradual benign flows back to JGBs from foreign bonds in 2025, albeit not expecting 2022-like fire sale.
On the other hand, benign nominal growth story accompanied by continued shift to structural inflation, corporate reform and BOJ normalisation are tailwinds to overall Japan equities given its “value” tilt.
Our scenario for the Fed rate cuts coming to light amid soft landing in the US would be positive to some under-owned cyclical growth sectors in Japan in 2025.
Ben Bennett, head of investment strategy, Asia
Legal and General Investment Management
In isolation, a weaker yen is not necessarily a bad thing for Japan – it improves export competitiveness and boosts inflation via the export channel, something the BOJ might welcome. Indeed, Japan’s reluctance to tighten policy means there is a large yield gap between Japan and the US, which should continue to attract flows and result in a weaker yen.
Having said that, policymakers are wary of excessive currency volatility introducing uncertainty and impacting economic activity. So, I think the base case is for further gradual depreciation of the yen with occasional supportive interventions when the daily moves become too volatile.
However, this is a major headache for other countries faced with very competitive exports from Japan thanks to the weak yen. They could also weaken their currencies, but they are wary about importing inflation.
Indeed, we’ve recently seen hawkish shifts from Australia and Indonesia while China’s central bank has also suggested bond yields should be higher, not lower. The result is a double economic headwind of monetary policy being tighter than desirable, plus some loss of competitiveness to Japan as the yen weakens.
What would alleviate this problem and make us more constructive about economic growth and currency strength across the region? Currency intervention is only a temporary help, but the Bank of Japan can provide a more sustainable solution if it meaningfully tightens monetary policy at its July 31 meeting. But US dollar strength more broadly can only be reduced by the Fed finally cutting interest rates.
Terrence Kan, client portfolio strategist
Fidelity International
The divergence in monetary policies between the US Fed and the BOJ and the resultant yield spread is currently driving the dollar/yen rate. And with the BOJ taking a gradual approach to policy normalisation, the yen is moving with US rates, which are, in turn, moving largely with expectations about US and global growth. That’s largely why weak yen and strong corporate earnings have occurred at the same time recently.
Looking forward, the outlook for global growth, the resiliency of the US economy and the repricing of Fed expectations will likely continue to determine such FX moves.
On the other hand, leading by the country’s shift towards moderate inflation and corporate governance reforms enacted by the Tokyo Stock Exchange (TSE), upbeat earnings results accompanied by share buyback announcements have served to galvanise market sentiment and encouraged renewed buying from overseas investors.
We believe that several structural factors will support the Japanese market over the mid-to-long term.
Firstly, there is the potential for a new phase of economic growth underpinned by a reflationary tide of rising prices and wages. Secondly, the actions by the TSE are driving expectations for further governance reforms and improvements in capital efficiency, leading to higher shareholder returns and investments in growth. Thirdly, a new capex cycle is emerging, supported by structural labour shortages and onshoring.
Finally, the recent uptrend in the market has been driven predominantly by overseas investors, although global portfolios remain underweight Japan. The domestic participation is yet to increase.
Christy Tan, investment strategist
Franklin Templeton Institute
Outside of the US, our experts think equities in Japan will likely outperform, in particular due to structural and corporate governance reforms in the country, which helps to underpin prospects of enhanced shareholder returns.
Furthermore, Japanese equities remain undervalued and look attractive relative to global equities at current valuations.
The Japanese yen also looks well-positioned to strengthen on the back of narrowing interest rate differentials with the US, and the yen looks significantly undervalued relative to historical averages.
However, despite the fastest wage growth in 30 years in Japan, real wages are negative this year with inflation at around 4% on average year-to-date, which has hampered domestic consumption.
Looking ahead, real wage growth is critical for a sustainable demand-led inflation that the Bank of Japan and the Japanese government is seeking to foster.
Recent renewed weakness in the JPY seems overdone and raises intervention risks from the BoJ. Observations based on interest rate differentials between the US and Japan continues to suggest wider scope for the recent JPY weakness to reverse.
Current market pricing of approximately two rate cuts by the Fed and two rate hikes by the BoJ are underpinning factor for correction in USD/JPY strength. Arguably, there are suggestions that JPY weakness is looking structural, partly as Japan’s primary income balance is large and may be reinvested abroad instead of getting converted into JPY.
Vincent Chung, associate portfolio manager
T. Rowe Price
The pace of the yen's depreciation might slow down from here. Considering that the current pace of depreciation is slower than in April, there should be no reason why 160 has to be the line in the sand. Most expectations suggest that intervention would likely occur if there were a quick depreciation to 163.
We believe that if the BOJ does not signal further rate hikes after July, the yen will likely weaken gradually towards 165 by the September Federal Open Market Committee meeting.
The key drivers for USD/JPY are still Fed rate cuts and domestic policy changes in Japan. However, in my base case, fast depreciation towards 170 in the next few months is unlikely as BOJ will likely intervene in the near term.
The depreciation of the foreign exchange makes it more likely that the BOJ will hike rates in July. This could put pressure on bond yields to move up in Japan. The current real rates for maturities shorter than 10 years remain negative. As the long end of JGBs get closer to the yields in Europe and China, investors should consider a potential increase in competition for funding worldwide. This could lead to upward pressure on global yields.
For FX carry trades, long USD/JPY is still popular from a carry perspective but as we near possible intervention levels of 163 or 165, the risk reward becomes less interesting. The CNY also has become a competitive funder in the region. A weaker CNY and JPY will also tend to place more pressure on regional FX. In terms of other popular carry trades such as Latin America FX long vs short JPY, those expressions have become much more volatile and therefore unlikely to build up back as quickly.
Naomi Fink, chief global strategist
Nikko Asset Management
Along with the BOJ's rate hikes, lagged cost-push inflation - in part driven by the yen’s weakness - is another downside risk; a weaker yen is helpful for large firms with overseas revenues, but less so for smaller, domestically oriented firms, which are sensitive to import price rises.
One of our global investment committee members was encouraged that buybacks are picking up (and with them, hopes of higher return on equity), although clear evidence of investments into restructuring and increasing productivity is sought as a key stock selection criterion.
Meanwhile, too rapid a USD/JPY reversal may prove disruptive for the large, listed firms who have been able to capitalise on the yen’s weakness to date, and this may prove a headwind for overall Japanese earnings in the absence of countervailing factors such as a pick-up in domestic demand.