BOJ Is About To Have Its First Rate Hike in 17 Years, But How Will The Global Market Be Impacted?

Following the conclusion of Japan's recent labor-management negotiations last week, where workers secured their largest wage increase in 30 years, the focus has now shifted to the next major move of the Bank of Japan (BOJ) concerning interest rates.

In January, BOJ Governor Ueda Kazuo underscored at a press conference that if wages and inflation achieve a virtuous cycle, the bank would consider changing its long-standing lenient policy, including negative interest rates, as increased wage levels could stimulate inflation in the service sector and actual consumption growth.

Now, for the BOJ and the Japanese economy, the nearly decade-long era of negative interest rate may finally come to an end.

However, given the enormous $4.43 trillion of assets held by Japanese investors overseas and the recent record highs of the Nikkei Index, many insiders are speculating about the impact of this potential rate hike, the first in 17 years, on the capital market.

A recent survey shows that even though the BOJ is likely to gradually adopt a stricter policy, most analysts believe that most funds held by Japanese investors are expected to stay in overseas markets, which is clearly good news for popular foreign assets such as U.S. stocks and U.S. bonds.

Respondents believe the BOJ's policy tightening will be gradual: by the end of the year, the bank will only raise short-term rates from the current negative 0.1% to a range between 0.01% and 0.5%. Therefore, in the short term, Japan will still have a large yield gap with other major economies such as the United States and Europe, so the upcoming interest rate changes should not prompt Japanese investors to take action.

Hideo Shimomura, a senior investment portfolio manager at Fivestar Asset Management, said: We're seeing large retail outflows into foreign bonds and equities and I don't think the end of the BOJ's sub-zero rate policy will change this trend.

Notably, over the past decade, Japanese funds have mainly flowed to the United States and the Cayman Islands in search of higher returns.

 

Also, despite mounting speculation about changes in BOJ policy, Japanese investors purchased as much as 3.5 trillion yen in foreign bonds in the first two months of this year. Bear in mind, that last year's total of 18.9 trillion yen invested in these assets was the highest in three years. However, based on current trends, this enthusiasm seems undiminished.

In addition, data shows that in recent months, Japanese individual investors have been increasing their purchases of overseas market securities.

Although domestic funds in Japan continue to outflow, it seems the local capital market is not worried given the Nikkei's increase this year: under the influence of factors such as a fall in the yen, easing monetary policy, improvements in the management of Tokyo Stock Exchange-listed companies, and the impact of AI, the Nikkei 225 has hit record highs this year.

 

As of now, the Nikkei 225 has risen nearly 20%, and the return on Japan's stock index (including reinvested dividends) has reached 45% in the past year. For comparison, the S&P 500 index return was 34% and the MSCI world index was 30%.

Indeed, the survey found that 45% of respondents believe that Nikkei stocks are structurally cheap.

Ayako Serai, a market strategist at Sumitomo Mitsui Trust Bank in Tokyo, said, There will be a dip in the market but I don't think that means we will be entering a downtrend. Should the dollar-yen fall to around 120, share prices will be affected but that's unlikely

In the past year, the yen has fallen about 10% against the dollar, making it the largest drop among 16 major currencies. The main reason is that while central banks in other countries and regions are vigorously tightening policies to curb high inflation, BOJ officials are still maintaining lax monetary policies.

Although it looks like BOJ officials are finally about to take action this week, 69% of respondents said they believe the yen's rate against the dollar at the end of the year will probably only be in the 120 to 140 range. Currency strategists expect that, given the limited extent of the BOJ's rate rise and the significant interest rate gap with similar rates in most overseas markets, the yen's rise will be capped at a few percentage points.

Alan Ruskin, Chief International Strategist at Deutsche Bank, believes that Any yen strength on tightening news with a benign signaling is prone to get reversed very quickly.

In general, from an external perspective, the BOJ's monetary policy adjustment this time is seen as the first step in the country's change of its extreme monetary stimulus measures aimed at promoting self-sustained growth of the economy. As for what kind of butterfly effect this change will eventually have on the world market, perhaps only time will give us the final answer.