Nomura: The hope for Japan to cancel tariffs has been shattered, and the U.S. may impose taxes first

Nomura believes that the progress of US-Japan trade negotiations has stalled, and Trump has threatened to impose tariffs of 30-35% on Japan, which will have a significant impact on investors.

According to the news from the Wind Trading Desk, on July 2, Nomura Securities' latest research report predicts that the Japanese stock market will continue to be under pressure, while the bond market may find support. Nomura Securities believes that the core contradiction in the current Japanese market lies in the macro-level deadlock of US-Japan trade negotiations and the micro-level economic resilience.

The report predicts that the US will first raise tariffs to increase the urgency for the Japanese public, after which both sides will propose concession plans and declare victory. This process is accompanied by two major risks: first, Japan may be forced to increase defense spending as a concession; second, the ruling Liberal Democratic Party may face significant defeat in elections due to negotiation failures. These two potential political variables will be important disruptive factors for the market.

Nomura analysts believe that the deadlock in US-Japan trade negotiations undoubtedly casts a shadow over the Japanese stock market. Coupled with the strengthening yen, investors should avoid risks in the Japanese stock market in the short term and refrain from chasing high stock purchases in this environment, while paying attention to allocation opportunities in long-term bonds.

Nomura stated that although the manufacturing outlook is bleak, the Bank of Japan's Tankan survey shows that the non-manufacturing sector performs strongly in price assessments and profit expectations. This indicates that there is recovery momentum within the Japanese economy, making the possibility of "interest rate hikes within the year" still exist (with a 40% probability of a rate hike in October). This expectation, combined with the weakness in the stock market, will provide support for Japan's long-term and ultra-long-term government bonds.

US-Japan Trade Negotiations Stalemated: Political Game Under Tariff Threats

The report clearly points out that the stagnation of US-Japan trade negotiations is the main source of pressure on the current market. This week, US President Trump stated that reaching an agreement with Japan "seems very difficult" and directly mentioned the possibility of imposing tariffs of 30-35%.

Although the market may not fully believe such statements, considering them likely "bluffing" in negotiation strategies, this uncertainty itself is enough to suppress risk appetite.

However, the Japanese government's initial goal of "completely eliminating US tariffs" has already gone awry, making it difficult for them to achieve a political victory in negotiations. Considering that the US has no intention of completely eliminating tariffs on specific countries, and its demands include politically sensitive items such as importing US rice, any agreement is likely to be delayed until after the Japanese Senate elections.

Analysts predict that negotiations may be delayed until after the Japanese Senate elections. The final solution may involve both sides escalating (for example, the US imposing additional tariffs) before making compromises and each declaring victory. In the course of the aforementioned negotiation game, investors need to be wary of the two core political risks mentioned in the report:

• Government Spending Expansion Risk: As a concession to the US, Japan may significantly increase its defense budget. This will raise market concerns about the expansion of government spending.
• Ruling Party Election Risk: Public opinion may sharply criticize the government's "mistakes" in negotiations, leading to significant defeat for the ruling Liberal Democratic Party (LDP) in the upcoming Senate elections At the same time, Nomura analysts pointed out that the possibility of Japan using exchange rate policy as a concession is currently still very small.

Bank of Japan's Tankan Survey Reveals Economic Resilience: Rate Hikes Still Possible This Year

In contrast to the pessimistic trade outlook, the Bank of Japan's Tankan survey report found some bright spots amid weakness.

The report noted that the data for the non-manufacturing sector was relatively good, with price assessments, profit outlooks, and capital expenditure (capex) projections all being revised upward compared to the last survey. This stands in stark contrast to the downward trend in various indicators for the manufacturing sector.

The report believes that although manufacturing may further slow in the second half of the year due to U.S. tariff policies, the recovery mechanism in the non-manufacturing sector is still at work. This suggests that the "virtuous cycle between prices and wages" closely monitored by the Bank of Japan may not have been interrupted. Based on this judgment, analysts believe that expectations for a rate hike by the Bank of Japan within this year are reasonable.

Data shows that the market's expected probability of a rate hike in October is 40%. While this level is not particularly high, it is sufficient to support market expectations for a rate hike. Based on the above macro background, the report provides a clear outlook for various asset classes in Japan:

• Japanese Stock Market: Will continue to be pressured by a strong yen and the deadlock in trade negotiations. The current environment is unfavorable for buying stocks. Although the overnight U.S. stock market showed sector rotation (tech stocks were sold off while consumer and cyclical stocks were favored) rather than net outflows of funds, the negative factors in the Japanese market are more pronounced.
• Japanese Bond Market: Will be supported by a weak stock market. Due to the lack of attractiveness of medium- and short-term bonds, funds may flow into long-term and ultra-long-term bonds. Although there will be a 30-year government bond auction tomorrow, investors' willingness to chase high prices is not strong. However, after the strong performance of the 10-year government bond auction yesterday, the prices of long and ultra-long bonds relative to swap products are rising, indicating an improvement in market supply and demand views.
• Foreign Exchange Market: The dollar is performing weakly. Although U.S. employment data exceeded expectations and temporarily boosted U.S. Treasury yields, the dollar's rebound could not be sustained. The USD/JPY exchange rate has fallen to the 143.5-144.0 range. The yen cross rates, which reflect market risk sentiment, have also begun to decline.

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