BOJ's Policy Credibility and Market Implications: Corporate Sentiment as a Barometer for Japanese Equities and Yen-Denominated Bonds

The Bank of Japan's (BOJ) evolving policy framework has long been a focal point for global investors, but recent developments suggest a critical inflection point. Corporate sentiment, a barometer of economic health and policy credibility, now reflects nuanced optimism about the BOJ's cautious normalization path. This optimism, however, is tempered by structural challenges and divergent views on the pace of reform. For investors, the interplay between corporate confidence and monetary policy signals a recalibration of risk and reward in Japanese equities and yen-denominated bonds.

Corporate Sentiment and Policy Credibility: A Delicate Balance

According to a report by Reuters, nearly half (47%) of Japanese firms approve of BOJ Governor Kazuo Ueda's performance in the recent quarter, a figure that underscores growing confidence in his strategy to phase out unconventional stimulus measuresNearly half of Japanese firms approve of BOJ chief's performance^[1]. This approval is attributed to Ueda's measured approach in ending negative interest rates, risky asset purchases, and yield curve control without triggering market turmoil. However, the same survey reveals a split in corporate opinion: 30% of firms view his actions as either too cautious or too aggressive, reflecting divergent views on the speed of normalizationNearly half of Japanese firms approve of BOJ chief's performance^[1].

This duality is mirrored in the BOJ's Tankan survey, which shows improved business sentiment among large manufacturers in Q2 2025, rising to 13 from 12 in MarchJapan's business mood improves despite tariff risks: BOJ Tankan^[4]. Despite global trade uncertainties—such as U.S. tariffs—manufacturers have demonstrated resilience, driven by trade agreements with the U.S. and the BOJ's ETF purchase program, which has stabilized equity markets by reducing the equity risk premiumData-driven monetary policy: Evidence from the Bank of Japan^[3]. Meanwhile, non-manufacturers face headwinds, with sentiment declining to 34 due to rising labor costs and weak domestic consumptionJapan's business mood improves despite tariff risks: BOJ Tankan^[4]. These mixed signals highlight the BOJ's balancing act: maintaining credibility through gradual normalization while addressing sector-specific vulnerabilities.

Equity Markets: Resilience Amid Policy Uncertainty

Japanese equities have shown remarkable resilience in Q2 2025, supported by the BOJ's interventions and improved corporate sentiment. The central bank's ETF purchase program, which favors riskier stocks, has acted as a stabilizer during periods of volatilityData-driven monetary policy: Evidence from the Bank of Japan^[3]. This predictability has reduced downside risks for investors, particularly in sectors aligned with the BOJ's portfolio preferences. For instance, technology and export-oriented industries have outperformed, reflecting confidence in Japan's integration into global supply chainsMonthly Market Review — July 2025^[2].

However, the Reuters poll suggests that corporate approval of Ueda's policies may hinge on how the BOJ manages its large ETF holdings. A majority (60%) of firms believe the BOJ should carefully plan its exit strategy for these assets, regardless of Ueda's tenureNearly half of Japanese firms approve of BOJ chief's performance^[1]. This underscores a key risk for equity investors: abrupt policy shifts could disrupt market liquidity and erode confidence. For now, the BOJ's measured approach appears to have mitigated such risks, but vigilance is warranted as the central bank navigates its transition to a more conventional monetary framework.

Yen-Denominated Bonds: A Tale of Two Yields

The BOJ's inflation forecast hike to 2.7% for FY 2025Japan's business mood improves despite tariff risks: BOJ Tankan^[4] has injected new dynamics into the debt market. While the central bank remains cautious about tightening further, the upward revision signals growing confidence in achieving its 2% target. This has led to a narrowing of the yield differential between Japanese government bonds (JGBs) and U.S. Treasuries, making yen-denominated bonds more attractive to yield-hungry investors.

Yet, the Reuters poll highlights a potential overhang: corporate inflation expectations remain anchored at 2.3% over the next five yearsJapan's business mood improves despite tariff risks: BOJ Tankan^[4]. This suggests that while the BOJ's credibility is improving, long-term inflation expectations have not yet broken free of historical constraints. For bond investors, this implies a cautious outlook: yields may rise incrementally as the BOJ exits stimulus, but sharp spikes are unlikely unless global inflationary pressures intensify.

Strategic Investment Opportunities

For investors, the current environment presents two key opportunities:
1. Japanese Equities: Sectors benefiting from the BOJ's ETF purchases (e.g., technology, industrials) and those poised to capitalize on trade agreements with the U.S. offer growth potential. Defensive plays in utilities and healthcare may also gain traction as the BOJ's policy normalization reduces market volatilityData-driven monetary policy: Evidence from the Bank of Japan^[3].
2. Yen-Denominated Bonds: High-quality JGBs and corporate bonds with short maturities could provide a hedge against currency risk, particularly as the yen's volatility stabilizes. Investors should monitor the BOJ's communication on ETF unwinding, as clarity here could unlock further yield opportunitiesNearly half of Japanese firms approve of BOJ chief's performance^[1].

Conclusion

The BOJ's policy credibility is being tested in real time, with corporate sentiment serving as both a mirror and a compass. While approval of Ueda's leadership reflects confidence in his cautious normalization strategy, the mixed views on his pace of reform highlight the fragility of this credibility. For investors, the path forward lies in aligning portfolios with the BOJ's evolving framework—leveraging equity resilience in sectors aligned with its interventions and capitalizing on the gradual normalization of yen-denominated debt yields. As the BOJ navigates this delicate balancing act, corporate sentiment will remain a critical signal for gauging market stability and investment potential.