The last samurai in developed markets

Written by Daniel Lam , Head of Equity Strategy at 渣打银行

Japan has long maintained an ultra-accommodative monetary policy, dating back all the way to the bursting of the asset bubble in the early 1990s. The Japanese private sector effectively switched from “investing to maximise profits”, to “paying down debt”, “saving” and basically playing defence. Interest rates have been maintained around the zero-mark for much longer than the other developed markets in order to encourage borrowing and spending.

In recent years, especially since the rolling out of the so-called Abenomics – economic policies by late former Prime Minister Abe – corporate Japan has started to re-emerge after more than two lost decades. Japanese companies have increasingly focused on profitability, and there has been a strong trend towards raising dividends and share buybacks. As if on cue, economic data in Japan has surprisingly been on the upside this year.

This turnaround naturally begs the question: When will the Bank of Japan (BoJ) finally end its ultra-loose monetary policy?

This question has become increasingly pertinent over the past year after other major developed markets, such as the US, the Euro area and the UK, significantly tightened their monetary policies to combat inflation that had risen to four-decade highs.

We believe that the BoJ is likely to unwind its ultra-loose monetary policy in Q4 of this year as inflation continues to run above the central bank’s 2% target and is on an uptrend.

However, the street is currently split over whether the BoJ will make a hawkish tweak to its Yield-Curve-Control policy (wherein it manages Japan’s 10-year bond yield within a tight band to prevent it from surging) earlier. Market expectations of an early BoJ tweak has led the USD-JPY to fall sharply from its year-to-date peak of 145 in July.

A clear move towards higher Japanese macroeconomic data in the first half of this year is why a number of economists are expecting the BoJ to act sooner rather than later.

Looking at card spending data, we can see a structural shift towards higher economic activity?– especially among younger people and for services consumption. For example, the spending on “going out” is growing at double digit levels – dramatically higher than the pre-Covid period.

The current spending pattern suggests that Japan is following the same reopening dynamics that led to entrenched inflation in the US and Europe last year.

The main pushback to any BoJ policy tweak in July is the central bank’s willingness to 'run?the economy hot' and to “err on the side of caution” lest policy is tightened too quickly and deflationary pressures return.

For example, there was a very slight softening in economic momentum in June, with headline consumer inflation, at 3.3% y/y, slightly below the expected 3.5%. However, the strong data over the first five months this year lends support for further normalisation in BoJ policy.

However, there is a rising risk that if the BoJ does not tighten now, they may need to tighten more aggressively further down the road.

Against this backdrop, we see a good opportunity to turn bullish on the Japanese Yen (JPY). We believe USD-JPY is likely reach the 130 level over the next 6-12 months, from the current level of around 140.

In our view, the risk-reward balance is even more favourable for the Japanese Yen versus European currencies. Investor positioning data shows that active investors are most bullish on the British Pound and the Euro against the JPY – conditions that typically make a contrarian idea more rewarding. In this case, bearish JPY positions against crowded European currencies are most at risk of a squeeze, particularly if inflation in Europe starts to decline.