The Resurgence of Inflation in Japan Shakes Up Investment Strategies

After an era characterized by deflation, Japan is now experiencing a notable rise in inflation, leading to significant changes in investment approaches. For a long time, Japan has been associated with persistent deflation, but the global tide of inflation is finally reaching its shores. This phenomenon is nudging the Bank of Japan (BOJ) to reevaluate its monetary policies. As a consequence, investors are rapidly modifying their strategies to adapt to this new economic environment.

Rethinking Investment in Japan

Historically, international investors leaned towards Japanese stocks that thrived on a robust elderly demographic and benefited from a weakening yen. However, the emerging inflationary pressures are shifting focus to sectors likely to prosper from rising interest rates, increased consumer spending, and more attractive dividends. Predictions of a sustained 2% inflation rate coming as soon as 2024 signal a significant shift, prompting consumers to advance big-ticket purchases and banks to experience heightened lending margins as interest rates possibly climb above zero, which hasn't been seen in years.

Market Reaction and Sectors to Watch

The Japanese stock markets are riding high, achieving levels not seen since 1990, with consumer and financial sectors presently outperforming. For instance, a crematorium company skyrocketed by nearly 700% over five years due to the aging population, while a company selling cake-making robots rose to prominence as a solution to labor shortages in the food industry. Now, financial institutions like the Kyushu Financial Group have taken center stage, under the belief that interest rates will rise. Similarly, consumer-driven businesses that can pass on rising costs, such as convenience stores, are observing increasing margins and earnings. Lastly, anticipation of substantial pay raises during the spring can catalyze further inflation.

Impact on Bonds and Currency

The resurgence of inflation casts a shadow over the future of Japanese government bonds, as they become less appealing with fixed interest returns in an inflation-ridden market. The BOJ's longstanding practice of keeping yields down by purchasing government debt may soon change, which would potentially lead to policy tightening. Bond market professionals remain wary, especially as yields on the five-year Japanese government bonds (JGB) rest at about 0.35%, which could be unfavourable if inflation rates rise. Moreover, shifts in the bond market are also expected to influence the yen's value, which may strengthen with tightened monetary policy heading into 2024.

inflation, Japan, investments