The Bank of Japan jolted global markets after its recent decision
to raise interest rates. Our experts break down the effects the
move could have on the country’s economy, currency and stock
market.
----- Transcript -----
Chetan Ahya: Welcome to Thoughts on the
Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.
Daniel Blake: And I'm Daniel Blake, from
the Asia Pacific and Emerging Market Equity Strategy Team.
Chetan Ahya: On this episode of the
podcast, we will cover a topic that has been a big concern for
global investors: Japan's rate hike and its effect on markets.
It's Thursday, August 22nd at 6pm in Hong Kong.
On July 31st, Japan's central bank made a bold move. For only the
second time in 17 years, it raised interest rates. It lifted its
benchmark rates to around 0.25 percent from its previous range of
0 to 0.1 percent. And at the press conference, BOJ Governor Ueda
struck a more hawkish tone on the BOJ rate path than markets
anticipated. Compounded with investors concern about US growth,
this move jolted global equity markets and bond markets. The
Japan equity market entered the quickest bear market in history.
It lost 20 percent over three days.
Well, a lot has happened since early August. So, I'm here with
Daniel to give you an update.
Daniel Blake: Chetan, before I can give you
an update on what the market implications are of all this, let's
make sense of what the macro-outlook is for Japan and what the
Bank of Japan is really looking to achieve.
I know that following that July monetary policy meeting, we heard
from Deputy Governor Uchida san, who said that the bank would not
raise its policy rates while financial and capital markets remain
unstable.
What is your view on the Bank of Japan policy outlook and the key
macro-outlook for Japan more broadly?
Chetan Ahya: Well, firstly, I think the
governor's comments in the July policy meeting were more hawkish
than expected and after the market's volatility, deputy governor
did come out and explain the BOJ's thought process more clearly.
The most important point explained there was that they will not
hike policy rates in an environment where markets are volatile --
and that has given the comfort to market that BOJ will not be
taking up successive rate hikes in an early manner.
But ultimately when you're thinking about the outlook of BOJ's
policy path, it will be determined by what happens to underlying
wage growth and inflation trend. And on that front, wage growth
has been accelerating. And we also think that inflation will be
remaining at a moderate level and that will keep BOJ on the rate
hike path, but those rate hikes will be taken up in a measured
manner.
In our base case, we are expecting the BOJ to hike by 25 basis
points in January policy meeting next year, with a risk that they
could possibly hike early in December of this year.
Daniel Blake: And after an extended period
of weakness, the Japanese yen appreciated sharply after the
remarks. What drove this and what are the macro repercussions for
the broader outlook?
Chetan Ahya: We think that the US growth
scare from the weaker July nonfarm payroll data, alongside a
hawkish BOJ Governor Ueda's comments, led markets to begin
pricing in more policy rate convergence between the US and Japan.
This resulted in unwinding of the yen carry trade and a rapid
appreciation of yen against the dollar.
For now, our strategists believe that the near-term risk of
further yen carry trade unwinding has lessened. We will closely
watch the incoming US growth and labor market data for signs of
the US slowdown and its impact on the yen. In the base case, our
US Economics team continues to see a soft landing in the US and
for the Fed to cut rates by three times this year from September,
reaching a terminal of 3.625 by June 2025.
Based on our US and BOJ rate path, our macro strategists see
USD/JPY at 146 by year end. As it stands, our Japan inflation
forecast already incorporates these yen forecasts, but if yen
does appreciate beyond these levels on a sustainable basis, this
would impart some further downside to our inflation forecast.
Daniel Blake: And there's another key event
to consider. Prime Minister Kishida san announced on August 14th
that he will not seek re-election as President of The Liberal
Democratic Party (LDP) in late September, and hence will have a
new leader of Japan. Will this development have any impact on
economic policy or the markets in your view?
Chetan Ahya: The number of potential
candidates means it's too early to tell. We think a major
reversal in macro policies will be unlikely, though the timing of
elections will likely have a bearing on BOJ.
For example, after the September party leadership election, the
new premier could then call for an early election in October; and
in this scenario, we think likelihood of a BOJ move at its
September and October policy meeting would be further diminished.
So, Daniel, keeping in mind the macro backdrop that we just
discussed, how are you interpreting the recent equity market
volatility? And what do you expect for the rest of 2024 and into
2025?
Daniel Blake: We do see that volatility in
Japan, as extreme as it was, being primarily technically driven.
It does reflect some crowding of various investor types into
pockets of the equity market and levered strategies, as we see
come through with high frequency trading, as well as carry trades
that were exacerbated by dollar yen positions being unwound very
quickly.
But with the market resetting, and as we look into the rest of
2024 and 2025, we see the two key engines of nominal GDP
reflation in Japan and corporate reform still firing. As you lay
out, the BOJ is trying to find its way back towards neutral; it's
not trying to end the cycle. And corporate governance is driving
better capital allocation from the corporate sector.
As a result, we see almost 10 percent earnings growth this year
and next year, and the market stands cheap versus its historical
valuation ranges.
So, as we look ahead, we think into 2025, we should see the
Japanese equity benchmark, the TOPIX index, setting fresh
all-time highs. As a result, we continue to prefer Japan equities
versus emerging markets. And we recommend that US dollar-based
investors leave their foreign exchange exposure unhedged, which
will position them to benefit from further strengthening in the
Japanese yen.
Chetan Ahya: So, which parts of the market
look most attractive following the BOJ's rate hike and market
disruptions to you?
Daniel Blake: Yes, we do prefer domestic
exposures relative to exporters. They'll be better protected from
any further strengthening in the Japanese yen, and we also see a
broad-based corporate governance reform agenda supporting
shareholder returns coming out of these domestic sectors. They'll
benefit from that stronger, price and wage outlook with an
improved margin outlook.
And we also see that capex beneficiaries with a corporate reform
angle are likely to do well in this overall agenda of pursuing
greater economic security and digitalization. So that includes
key sectors like defense, real estate, and construction.
And Chetan, what would you say are the key risks to your view?
Chetan Ahya: We think the key risk would be
if the US faces a deeper slowdown or an outright recession. While
Japan is better placed today than in the past cycles, it would
nonetheless be a setback for Japan's economy. In this scenario,
Japan’s export growth would face downward pressures given
weakening external demand.
The Japanese corporate sector has also around 17 percent of its
revenue coming from North America. Besides a deeper Fed rate cut
cycle, will mean that the policy rate differentials between the
US and Japan will narrow significantly. This will pose further
appreciation pressures on the yen, which will weigh on inflation,
corporate profits, and the growth outlook.
And from your perspective, Daniel, what should investors watch
closely?
Daniel Blake: We would agree that the first
order risk for Japan equities is if the US slips into a hard
landing, and we do see that the dollar yen in that outlook is
likely to fall even further. Now we shouldn't see any FX (foreign
exchange) driven downgrades until we start bringing the yen down
below 140, but we would also see the operating environment
turning negative for Japan in that outlook.
So, putting that aside, given our house view of the soft landing
in the US economy, we think the second thing investors should
watch is certainly the LDP leadership election contest, and the
reform agenda of the incoming cabinet.
Prime Minister Kishida san's tenure has been focused on economic
security and has fostered further corporate governance reform
alongside the Japan Stock Exchange. And this emphasis on getting
household savings into investment has been another key pillar of
the new capitalism strategy. So, these focus areas have been very
positive for Japan equities, and we should trust -- but verify --
the commitment of a new leadership team to these policy
initiatives.
Chetan Ahya: Daniel, it was great to hear
your perspective. This is an evolving story. We'll keep our eye
on it. Thanks for taking the time to talk.
Daniel Blake: Great speaking with you,
Chetan.
Chetan Ahya: And thanks for listening. If
you enjoy Thoughts on the Market, please leave us a review
wherever you listen and share the podcast with a friend or a
colleague today.
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