Yen Weakness May Support Japan Equities

Can a weakening yen (JPY) continue to bolster Japanese equity markets? If historical relationships remain intact, the answer may be yes.

The JPY has steadily depreciated against the dollar (USD) this year, losing more than 15% as the worst performing G10 currency.

This isn’t unprecedented, however, considering the headwinds driving the yen lower versus the greenback. The U.S., much like the rest of the global economy, is wrestling with the highest inflation in four decades, rapidly forcing the Federal Reserve into monetary tightening. Speculation about where the rate hike cycle may ultimately conclude over the next 12-24 months is driving the USD higher. Despite some of the highest readings in inflation in the last decade, the Bank of Japan (BoJ) has remained committed to its accommodative policies of negative short-term interest rates and yield curve control. As a result of ever-widening interest rate differentials between the U.S. and Japan, the JPY has weakened dramatically.

Implications for Japanese Equities

The JPY has historically been negatively correlated with Japanese equity markets, owing to the orientation of Japan’s economy toward exporters. Among G10 currencies, it’s also the most negatively correlated to its domestic equity market over the long term, even surpassing the USD on a rolling 10-year basis. Although correlations have increased over the last several months, they remain firmly in negative territory on a rolling 60-month basis.

Rolling 60M Correlation between Yen & MSCI Jspan

Figure1and2_Rolling 60 M correlation Yen and MSCI Japan