Japan – Feature
Japan stands out among its peers. It is the only major devel- oped economy that has not committed to quantitative tighten- ing and is not yet facing significant inflation. Both trends have bolstered stock market performance. With the Nikkei and Topix performing relatively better than other developed market indices, Japan has caught the eye of institu- tional investors. But how long can a developed market economy afford to diverge from its peers?
Amid falling stock markets in Europe and the US, does Japan still offer investors diversification?
Divergence So far, this year has been rough for equity investors. Faced with the onset of monetary tightening in the US and Europe, the S&P500 has dropped by more than 14%, year-to-date, while the Eurostoxx 50 has fallen by around the same level since the beginning of the year. But Japan stands out. While Japanese indices such as the Nik- kei and Topix have also declined, they have fallen relatively less, by around 5% year-to-date. Why is the Japanese economy following a different path? A widening gap in currency values is one factor that makes the Japanese economy stand out against other developed markets. While the dollar continues to face structural appreciation pres- sures, Japan has a long history of competitive devaluations to keep the yen’s value low and bolster export markets. This trend has been accelerated by the war in Ukraine argues Clay Lowery, executive vice president for research and policy at the Institute of International Finance.
“The war in Ukraine has impacted the yen, as it has many global economies by exacerbating supply chain disruptions and harming commodity importing and Japan is a significant commodity importer, particularly of energy. After Russia invaded the Ukraine, the yen depreciated against the US dollar by a further 6%.” But another, potentially more significant factor is the diver- gence in monetary policy. Japan, as the birthplace of quantita- tive easing, continues to face low inflation and has, therefore, not yet committed to monetary tightening. While the Federal Reserve, the European Central Bank and the Bank of England all have committed to monetary contraction, the Bank of Japan has held back. Compared to other developed markets, it faces relatively low inflation of 2% and has, therefore, less pressure to raise interest rates.
Japan has pulled away from the crowd when it comes to monetary policy and investors could benefit. Mona Dohle reports.
The combination of loose monetary policy and a falling currency go hand-in hand, Lowery says. “The result is that the interest differentials between the United States’ 10-year bond yields and Japanese debt have spiked roughly 350% since 2020. “To put it simply, holding dollar-backed bonds provides a much higher return than yen-backed bonds, which is a catalyst for
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