Article20 Mar 2024

Japan’s Long Journey Towards Policy Normalization

Asia Pacific Strategy

Another stark pattern emerged since 2020, which is that when the yen was strong, correlation fell even more.

Key Takeaways

  • At last, the Bank of Japan (BOJ) ended its negative interest rate policy and yield curve control. But the BOJ also decided to keep bond purchases to stabilize the government bond market. Governor Ueda also noted his preference to keep policy accommodative until the long-term inflation target is reached. These developments were interpreted as very dovish, taking Japanese yields and the yen lower, while equities gained.
  • However, we see the policy stance as essentially data driven. This appears consistent with the BOJ’s patterns over the past two years. Given rising wages and moderating inflation, with growing corporate profits and rebounding investment, Japan’s economy is likely to support further steps to normalize policy by the BOJ.
  • Near term, we expect the yen to stay range bound between 148 and 152, as the BOJ is likely to keenly watch Japanese Government Bond (JGB) market stability, while also possibly intervening if the yen weakened too much. The US Federal Reserve (Fed) is also unlikely to cut rates in the coming quarter.
  • However, in the medium term, we continue to expect the BOJ to normalize policy, while the Fed is likely to reduce rates. Both sides are needed in order to send the yen towards the 130-135 area.
  • Although the March BOJ meeting did not strengthen the yen, investors remain concerned over how potential yen strength might affect Japanese equities. We observe that equity yen correlation had collapsed from 60% pre-pandemic to just 12% since 2020. If yen strength is driven by higher Japanese yields and lower US ones, without a US recession, Japanese equities had shown strong resilience.
  • We also see that Japanese equities are more correlated with earnings than with the yen. Among sectors, Healthcare, IT, and Telecom have earnings that are negatively correlated with the yen, while Utilities and Energy have the highest correlations.

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