Japan Market Outlook

Policy outlook—Can Japan maintain its accommodative stance?

There is no immediate urgency for the BOJ to change its accommodative stance, but our base‑case scenario is that it will terminate the current negative interest rate policy in April 2024 to coincide with the annual wage negotiations. This is also the time when the BOJ will include fiscal year 2026 in its forecasts, providing an additional year of forecasts, where the BOJ can signal rising confidence in higher inflation.   

The other key decision facing the Bank of Japan is when—and how—to remove its yield curve control (YCC) policy. While this could happen as early as December this year, the YCC policy has already been gradually winding down, with the parameters of the 10-year yield cap being loosened toward the point of becoming irrelevant, as evident when the BOJ recently loosened the yield cap from a strict 1% limit to a more flexible “reference” rate.

Currency outlook—How low can the yen go?

The steep decline in the value of the yen, relative to the US dollar, has been a central narrative in Japan for more than a year and a primary influence on Japan’s strong equity market returns. Currently around multi-decade lows, the weak currency has been particularly supportive of Japan’s export‑heavy TOPIX index, with large, multinational auto companies and manufacturers benefiting greatly from their increased competitiveness. This has also meant that value-oriented companies have powered the market, significantly outperforming their growth-oriented counterparts. The swing toward value and away from growth in Japan in recent years has been significant. However, this differential looks increasingly stretched, compared with history, raising the potential for growth companies and more domestically focused businesses to rally in 2024 from depressed valuation levels.  Should we see, at some point, a decline in global interest rates and a stronger yen, this would be a particularly supportive backdrop for growth companies.

Governance outlook—Prioritizing capital efficiency and higher shareholder returns

Japan investors should not overlook the ongoing corporate governance reform. These efforts are effecting meaningful change—change that will likely have a greater bearing on long-term equity returns than the country’s monetary policy.

Recently, Japanese authorities have doubled down on reform measures, targeting the deep‑seated issue of capital inefficiency among Japanese companies. In early 2023, the Tokyo Stock Exchange (TSE) announced new rules requiring companies trading below a price/book ratio of 1x to improve or risk being excluded from the new Prime 150 Index. Perhaps more importantly, noncompliant companies will be required to explain why they remain so and to disclose action plans to increase their price/book ratio to 1x. While the TSE’s ambition is to weed out the worst‑run Japanese companies, the broader aim is to see sustainable improvement in returns on equity across corporate Japan. To date, just over half of the companies listed on the TOPIX have responded to this pressure, so the potential for further value creation, as more companies meet the threshold, is substantial (Fig 3).

Closing the gap with major market peers

In summary, the outlook for Japan is encouraging going into 2024, with expectations of robust economic growth and improving inflation that shows signs of being sustainable. The health of the global economy remains an important factor in this positive view, while accommodative policy and a weak currency are also key supports. Any potential moves to tighten policy via a hike in interest rates represent a key risk to the outlook. Given the BOJ will not want to risk undoing all the good work achieved to date, we believe it will remain dovish in its communication and keep policy accommodative.

On the market front, there is still a lot of hidden value to be revealed, particularly as reform measures gain traction, complicated cross-ownership structures are unwound, and companies are forced to allocate capital more efficiently. Improving returns on equity should see corporate Japan become more competitive with global peers and attract an increasing allocation of foreign capital investment.

Global Market Outlook insights