How Yen Trends & Wage Growth Signal Opportunities in Nikkei 225 By Danish Lim Zhi Lin, Investment Analyst
Current Performance of Nikkei 225 Index:
Since our last trade idea ( ), the Nikkei 225 Index has rebounded from around 36,215 on 9 September to 39,480 at the close on 6 November, a gain of about 9%.
Nevertheless, Japanese equities are yet to hit their July record highs, as a stronger Yen, political uncertainty, and potentially higher interest rates weighed on sentiment.
Green Shoots in Japan:
In our previous posting, we highlighted how the fundamentals behind Japanese equities remained unchanged despite a bout of volatility in August and September. We viewed the August drawdown in equities as temporary and believed it was tied to headwinds in the global economy rather than Japan itself. Rising real wages provided further optimism that a virtuous wage-price spiral could be achieved, potentially boosting consumer spending and sentiment.
The latest data on wages supported our view, as Japanese workers’ base salaries saw the largest increase in over 3 decades, backing the BOJ’s view that the economy remains on the recovery track. Base pay advanced 2.6% YoY in September, up from 2.4% in August, the strongest increase in over 31 years. Scheduled cash earnings, a more stable measure of wage trends that excludes overtime pay, rose by 2.9% YoY, up from 2.8%. However, real wages fell for a 2nd straight month.
Nevertheless, wage hike momentum remains steady despite pockets of weakness, this could fuel spending and lead to demand-led inflation. At the same time, corporate reforms and growing shareholder activism have also led to higher dividends, more share buybacks and stronger balance sheets.
While the BOJ kept rates unchanged at its last policy meeting, there is still a possibility of another rate hike further down the road.
US Elections and USD/JPY:
On 6 November, the Nikkei 225 closed up by 2.61%, as the USD/JPY currency pair rose to 153.93 at 15:39 SGT, potentially on the verge of testing the key psychological level of 155. The negative correlation between the Nikkei 225 and USD/JPY has been well documented, with a weaker Yen benefitting many export-heavy Japanese firms such as Toyota and Fast Retailing, parent of Uniqlo.
The rise in the Dollar was driven by an increase in yields across the Treasuries curve following the US election results; as traders positioned for Trump’s tariffs to drive up inflation and tax cuts to boost the budget deficit.
In our view, we believe that the USD/JPY currency pair has more room to extend its rally for the remainder of the year. This could potentially provide further support for the Nikkei 225.
Back in 2016, Trump’s election victory saw the Dollar Index surge over 3% in October, similar to what happened last month. However, the Dollar Index rallied another 3% in November 2016. We could see a similar picture playing out this year. We also expect the Fed to slow its pace of rate cuts, given the inflation-inducing policies Trump is expected to push.
BOJ: To Hike or Not to Hike?
Following Donald Trump’s election win, Japan’s chief currency official Atsushi Mimura said that “we’re seeing one-sided, sudden moves in the currency market” as the yen weakened towards the 155 level against the Dollar. Mimura added that the central bank will monitor markets with a “very high sense of urgency”.
A weak Yen has the potential to boost imported inflation, putting pressure on the BOJ to raise rates. We expect to see verbal intervention from officials if Dollar strength remains in place. A breach of the 160 level could prompt actual currency intervention from the government.
Japan’s Politics
The situation is further complicated by the recent loss of a parliamentary majority by Japan’s ruling Liberal Democratic Party (LDP) in last month’s lower house election. This outcome could force the LDP to form a new coalition, potentially leading to power-sharing agreements that introduce political uncertainty.
Such developments could delay the Bank of Japan's (BOJ) anticipated rate hike, with opposition parties—some of which may become pivotal in coalition negotiations—advocating for a more dovish monetary stance.
Notably, Yuichiro Tamaki, leader of the opposition Democratic Party for the People (DPP), has called for a six-month delay before any further rate hikes.
As a result, the prospects of delayed BOJ tightening, combined with rising US yields driven by the policies of a potential Trump administration, have led to a widening of the interest rate differential between Japan and the US, now at its most pronounced since July. This dynamic has exerted upward pressure on the USD/JPY exchange rate.
The US-Japan 10-year yield spread has increased from its September low, which aligns with the recent rise in the USD/JPY currency pair. ()
Nikkei 225 Outlook & Trading Opportunity:
In our view, we see Trump's election victory as tactically positive for Japanese equities and the Nikkei 225.
The underlying economic fundamentals remain robust, with real wages on a positive growth trajectory. The resurgence of healthy inflation coupled with rising wages could trigger a virtuous cycle of price and wage increases, which would provide a broad economic boost and, by extension, benefit the equity market.
Trump's election victory could also alter the flow of capital into 2 of Asia's largest equity markets. Specifically, as investors adopt a more cautious stance towards potential tariffs on China, we anticipate that funds will increasingly flow into Japan.
We expect the Nikkei 225 to benefit from Trump’s inflationary policies - which could keep US interest rates high, which could in turn strengthen the Dollar and weaken the Yen to the advantage of the Japanese equity market. However, upside could be limited given the risk of a currency intervention by Japanese authorities to stem Yen weakness.
If China's expected stimulus measures fall short of market expectations, we anticipate that investors may rotate their positions out of China and into Japan, a pattern we already observed during the lead-up to China’s previous round of stimulus announcements..
Expressing Our View:
We maintain our previous trade setup:
Long Nikkei 225 Index Futures
Based on a Fibonacci Extension drawn from the October 2023 to the July 2024 high, the daily chart shows the index rebounding from the 5 August low of 31,156; but has since consolidated within 37,700 – 39,500.
If Dollar strength remains, we expect an appreciation in USD/JPY to send the Nikkei 225 Index upwards towards resistance at the 0.786% extension level around 40,500 within the month of November. If breached, we see the next resistance level at around 43,000 – 43,050.
• Entry Level: 39,000
• Target Level: 40,500 (1-Month target)
• Stop Loss Level: 38,500 (trailing stop preferred)
• Profit at Target: 1500 x ¥500= ¥750,000
• Loss at Stop: 500 x ¥500= ¥250,500
• Reward: Risk Ratio: 3x
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