Weekly market commentary

Twelve-month returns for the MSCI Japan are near 14% in US dollar terms. We don’t see the recent slide in the yen to 34-year lows versus the dollar derailing this momentum. Why not? Japan’s growth outlook remains positive, corporate reforms are taking hold and rising wages can support consumer spending. Ultimately, yen weakness is mainly due to the gap between Bank of Japan and Fed policy rates. The yen could recover once the Fed cuts. We stay overweight Japan’s stocks.

A growing gap

Difference between US and Japan 10-year bond yields, 1990-2024

At the end of April, the yen tumbled to near 160 to the dollar – its lowest in 34 years. The Japanese authorities appear to have intervened by buying US dollars, warning investors betting against the yen and helping slow its slide. Any near-term drivers aside, we think the yen’s weakness is caused by the gap between Fed and Bank of Japan (BOJ) policy rates. The Japanese currency started depreciating in 2022 as the Fed started hiking rates rapidly. Its fall accelerated in April as the BOJ affirmed it would not rush to unwind its loose policy, while markets pared back their pricing of Fed rate cuts for this year given sticky US inflation. Government bond yields for the US and Japan reflect that gap in the market’s monetary policy expectations. Ten-year US Treasury yields have surged above Japanese government bond yields, with the difference close to two-decade highs. See the orange line in the chart.

Yet we think that gap between US and Japan 10-year yields could narrow again as BOJ and Fed policy rates begin to move closer to each other. Sticky U.S inflation may mean the Fed will keep interest rates high for longer, but we still see it starting to cut them later this year. And the BOJ is likely to hike rates again as it cautiously normalises its emergency policy of negative interest rates. That should ease pressure on the yen. That said, should the yen weaken significantly between now and then, it could stoke inflation as the cost of imported food and energy rises. The BOJ could respond by tightening policy more rapidly. But we think that’s unlikely as it would risk threatening an improving growth outlook, and victory in its decades-long battle against no or low inflation is not yet assured. We see government subsidies on food and energy as a more likely response.

The impact of a weak yen

A weak yen affects Japanese firms differently. Manufacturers with higher input costs may see lower earnings. Yet as Japan’s goods become cheaper for foreign buyers, that will benefit the exporters that make up over half the market capitalisation of Japan’s TOPIX index. As recent wage negotiations lead to higher wages, a strong consumer could support some sectors.

Japanese stocks have surged, based on the excess yield that investors receive for the risk of holding them over bonds. But we stay overweight Japanese stocks on a six- to 12-month, tactical horizon. The rally is a sign investor confidence is perking up. And a weaker yen doesn’t change the reasons behind our positive stance. The return of inflation in Japan means companies can raise prices and expand their net profit margins. Plus, shareholder-friendly corporate reforms are taking root, with more firms joining the Tokyo Stock Exchange’s list of those with plans to improve their governance. Government initiatives to encourage more domestic savers to invest could boost flows into Japanese stocks. These shifts are playing out over time. We also see mega forces – big structural shifts driving returns – creating long-term opportunities in Japan. For example, Japan’s population has been aging for many years. That has propelled efforts to adopt automation to boost productivity.

Our bottom line

We see diverging monetary policy driving the slide in the yen, but we don’t see the pressure persisting. We stay overweight Japanese stocks given ongoing corporate reforms and eye opportunities created by structural shifts.

Market backdrop

The S&P 500 climbed higher last week, approaching its 2024 highs. US 10-year Treasury yields hovered around 4.50%. Given structurally higher interest rates, the onus has fallen on earnings to sustain US equity strength. US Q1 earnings have cleared a high bar thus far, showing strong results and signs of broadening. Japanese equities and 10-year government bond yields were flat. A historically weak yen, near 34-year lows versus the US dollar, prompted suspected currency intervention.

We await US CPI inflation data this week as some components have recently been higher than expected. We’re eyeing whether that will carry on. Supercore services inflation excluding food, energy and housing is particularly in focus as it will determine where inflation ultimately settles. We’re also watching core goods given their bumpy post-pandemic normalisation. After softer-than-expected US payrolls and wages, markets are again expecting a September rate cut.

Read our past weekly commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, May 2024

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024.

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, May 2024.

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