Strong yen a major new headwind for Japan stock market

While in the US, slower rise in inflation rate is fuelling hopes for more measured rate hikes by the Fed going forward, accelerated rise in inflation rate in Japan as underlined by the Tokyo CPI data last week is raising anticipation of further tweaks to BOJ’s yield curve control (YCC). BOJ’s pretext that its tweak in YCC in December was mainly done to improve liquidity in the JGB market has not only failed in its objective but the central bank has been forced to buy even more bonds to defend its new rate ceiling, leaving Japan’s sovereign debt market even more illiquid. 

As we have predicted since November, this divergence in interest rate outlook is leading to a fast appreciation of the yen, especially against the US dollar. Indeed, our forecast that the dollar/yen rate should break below 120 level by summer is not only looking increasingly likely but could come much sooner than we had anticipated.

This trend as we have also forewarned will provide a major headwind for Japan’s stock market as overseas earnings of Japanese corporations which have been notably flattered by weak yen in previous quarters are now likely to be revised down due to the reversal in the value of the Japanese currency which has fallen below most corporate forex projections. This is especially the case as end-demand is still weakening. 

We also believe that the Japanese currency is likely to regain its key characteristic as a safe haven trade this year, especially as geopolitical backdrop remains highly volatile. As we noted last week, US budget deficit will likely to take centre stage by June as the Republican majority in the US Congress could provide a major obstacle in raising the country’s statutory debt ceiling of $30trn. Last Friday US Treasury secretary, Janet Yellen warned that the spending limit will likely be breached by next week. 

Another reason to expect more geopolitical tensions that could strengthen the yen is that the Republicans in the House have quickly gathered bipartisan support to establish a Select Committee on the Strategic Competition Between the US and China. We think this committee will likely pass legislations to expand on existing technology export bans to the country, attempt to limit US private investments in Chinese entities and ultimately accelerate the decoupling of supply chains away from China. 

Nevertheless, Chinese stocks have continued to rally, ignoring the above as well as the unprecedented Covid wave in the country which by some estimates have already engulfed nearly 1bn of its population, even before the lunar new year. We thus believe there is much to be concerned about regarding more slowdown in China’s economy as well as potential for more stricter border controls for Chinese travellers as concerns among global health officials about potential for new Covid variants remain elevated.