Japan Outlook 2023 – HY update

Japan’s economy has regained momentum in 2023 amid signs of a sustained return to inflation this year. Along with that, the country’s TOPIX and Nikkei 225 index hit a 33-year high in the last few weeks. How does this help the overall Japan outlook for the second half of the year? Investment experts share their views on the development of Japan’s financial assets through the second half of 2023. 

Japan Economy

The first quarter of this year saw Japan’s GDP grow by 2.7%, exceeding prior expert predictions of 1.6%. Looking forward, the projected 1.1% GDP growth for 2023 and 2024 indicates robust nominal growth for Japan, according to Morgan Stanley. 

“This would be a momentous change for Japan, where nominal growth has been basically in a flat range for a long period…It implies simultaneous growth for employee compensation and corporate earnings, a large increase in tax revenue and potentially positive effects on asset prices,” says Morgan Stanley’s Chief Japan Economist Takeshi Yamaguchi.  

Furthermore, after years of disinflation, Japan’s headline inflation reached a four-decade high of 4.2% in January before falling to 3.4% in April. “Although the central bank currently expects inflation to ease later this year, it may prove to be more enduring…Japan is still nowhere near the inflation that the US or Europe has seen recently, but several signs suggest that inflation may struggle to move lower without central bank intervention,” writes Michael Wolf, Global Economist at Deloitte. 

“We project Japan’s CPI inflation will slow in H2 as import costs trend downward. The current record price passthrough is unsustainable given sluggish demand and firms’ weak pricing power,” as per Oxford Economics.  

Archibald Ciganer, Portfolio Manager at T. Rowe Price, believes that despite expected higher short-term market volatility, the outlook for Japan looks favourable. “Signs of a sustainable return of inflation, particularly wage inflation, in Japan, is encouraging and a huge boost for investor and business sentiment alike,” writes Ciganer. 

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Japan Equity

Japan’s stock markets have outperformed their Asian counterparts so far this year. In recent weeks, the Nikkei 225 and Topix indices reached their highest levels in more than 30 years as international investors poured money into Japanese stocks in quantities not seen in at least ten years. 

“Japan equities hit a 33-year high in May, underpinned by strong corporate earnings and renewed interest from foreign investors encouraged by growing expectations for accelerated corporate reforms. Tailwinds from the domestic reopening post-COVID, the normalisation of the Chinese economy and supply chains, and the recent price increases have boosted profits,” says Eastspring Investments.  

“Ongoing corporate restructuring continues to enhance shareholder value. The long-term upward trajectory for earnings and margins remains intact,” the asset manager added.  

As per Fabiana Fedeli, Chief Investment Officer, Equities and Multi Asset at M&G Investments, there are signs that investors are starting to recognise the potential growth opportunity among Japanese corporates after years of short-lived excitement and false starts.  

“We have found a number of companies that are improving operational leverage with a positive impact on earnings growth, alongside increasing shareholder returns via raising dividends and share buybacks…However, less well recognised in our view…is the prospect of wage growth boosting consumption, providing a further potential tailwind for growth in the years ahead…,” writes Fedeli.  

“In the case of Japan, upward growth momentum in domestic demand, and structural reforms to improve shareholder returns could lure investors to further diversify their international holdings,” opines J.P. Morgan Asset Management.  

Japanese Bonds 

The Bank of Japan announced a shift in interest rate policy earlier this year, enabling ten-year bond yields to rise. It also announced an expansion of its bond-purchasing programme. The Bank of Japan’s new governor, Kazuo Ueda, has acknowledged that the bank’s current ultra-loose policy is unsustainable, but he has also stated that the bank is not in a rush to undertake adjustments.  Here is what the experts had to say talking about Japan outlook within fixed income.

“Relative to other major world economies, Japan remains a policy outlier… It continues to adhere to its largescale bond buying yield curve control (YCC) strategy, with 10year JGB yields allowed to fluctuate in the range of around +/ 0.5% from the target 0% level…,” writes Archibald Ciganer, Portfolio Manager at T. Rowe Price.

“YCC worked well when inflation was low; however, as inflation has started to rise, investors have sold lowyielding bonds, forcing the BoJ to ramp up its buying to maintain its yield range target. Amid growing criticism of distorting market pricing, the strategy has caused the value of the yen to fall sharply and, in turn, inflated the cost of raw material imports,” adds Ciganer.  

Citi Bank believes that BOJ will eliminate YCC before the end of 2023. “We expect that the Bank of Japan will purposefully exit its ultra-loose monetary policy, which could take place in the second half of this year. If this happens, the yen has room to strengthen further,” says Citi Bank.  

“We think it’s unlikely that, at that point, interest rates will rise above 1% for the 10-year JGB, considering prevailing inflation trends, the correlation between US Treasury bonds and JGBs, and the yield differentials within the JGB market…Meanwhile, we expect Japanese policymakers to maintain NIRP (Negative Interest Rate Policy), so long as the dollar-yen exchange rate remains below 150,” as per Alliance Bernstein.