The End of the Nikkei’s Rise? And What About the Yen?

Like all stock markets around the world, Japan’s benchmark took a spill when the pandemic broke out. It then recovered handsomely and experienced a second wind during last winter.

This led many analysts to speculate that the Nikkei was on track to finally recover from the crash it experienced back in the late ’80s.

Then… well, a lot of things happened. The index took a few runs at the 30K level but did not manage to breakthrough.

So far, all moves to break that psychologically important level have failed. Now, global central banks are looking to reduce liquidity injections as the pandemic appears to finally be abating.

This means increased outflows from safe-haven investments like Japan, and less money available for investments in the stock market.

Does this mean the end of the rally?

The new Japanese Prime Minister Kisida made his first address in Parliament, outlining his program. Among the matters of interest for the markets was an initiative to raise capital gains taxes to 25% from the current rate of 20%.

The PM said this was possible without negatively impacting stock prices. Whether you agree with that somewhat unorthodox sentiment, the Nikkei closed higher following the remarks. This is perhaps because traders put more weight on his other comments.

Kishida insisted that he would not hesitate to spend in order to respond to crises, and set defeating deflation as his top priority. The new tax policy might fight in that view, as many economists generally believe that taxes are passed on to consumers.

The last time Japan raised taxes – albeit on sales – there was an increase in CPI in response.

Is it a good investment?

Fiscal policy that could increase inflation in Japan would be expected to weaken the currency in general.

The new PM’s promise to spend more would likely imply increased imports, which would reduce demand for the currency. In general, Kishida’s statements could be interpreted as being negative for the yen in the long term.

Unsurprisingly, the market reacted with a weaker yen, as the USDJPY rose to levels it hasn’t sustained for a few years.

Traditionally, a weaker currency correlates with improvement in the stock market. Particularly in the case of Japan, where even though there is a lot of effort in that direction, inflation has remained largely subdued.

In a world of higher inflation in major reserve currencies, yen-denominated assets offer a certain amount of attraction. Even if the currency might depreciate 2-3% over the next year; that’s less than the expectation for inflation in other major currencies.

Will the policy work?

The next major event in Japan that could derail the current outlook is the general election.

Typically, there is no surprise result, with Kishida widely expected to get a popular mandate. However, elections provide an opportunity for MPs to talk to their constituents, and that might change some of the government’s economic priorities.

For now, covid has been a dominating factor in politics. But Kishida was specifically chosen to put that in the past and focus on the economy.

With the world generally moving away from safe-haven assets, albeit slowly, there might be an opportunity for the Nikkei to gain some ground and finally get over that 30K obstacle. Assuming the current array of circumstances can be maintained.

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