The central bank's communication mechanism helps Japanese stocks make a comeback: the shadow of arbitrage trading unwinding gradually dissipates, and foreign capital accelerates its layout

Zhitong Finance APP learned that the market turbulence caused by the significant rebound of the yen a year ago is still fresh in memory. At that time, the Tokyo and New York stock markets plummeted due to the unwinding of arbitrage trades, but now the Japanese stock market has stabilized. Despite experiencing two major corrections and a large-scale unwinding of arbitrage trades, global investors who had borrowed low-interest yen to invest in high-yield currencies faced shocks. However, the market landscape has quietly changed in the twelve months since August 5, 2024.

In August last year, the Bank of Japan unexpectedly raised interest rates by 15 basis points, leading to a 12% single-day drop in the Nikkei 225 index, with a market value evaporating by over $670 billion. Currently, the TOPIX index is hovering near historical highs. Although the summer stock market rally this year shares similarities with the technical characteristics of July last year, market participants generally believe that a crash in 2024 will not be repeated.

Analysts point out that the Bank of Japan's more transparent policy communication, ongoing corporate governance reforms, and better-than-expected US-China tariff agreements have collectively built a more stable market environment.

"The foundation for the current rise is clearly more solid," said Pelham Smithers, founder of a UK-based Japanese equity research firm. "The market has formed expectations that the Bank of Japan will continue to raise interest rates." Although the yen remains volatile due to US economic data, such as the weak non-farm payroll data on August 2 that pushed the yen to appreciate by 2% against the dollar in a single day, leading to a drop of over 1% in the TOPIX and Nikkei 225 indices the following day, the overall volatility has significantly contracted compared to the same period last year. As of August 5, the yen to dollar exchange rate was approximately 146.95, far below the 10% sharp increase seen in the same period of 2024.

Anna Wu, a cross-asset strategist at VanEck in Sydney, believes that the market has adapted to the new normal of Japanese interest rate hikes. "Although the Bank of Japan is indeed tightening its policy, the interest rate differentials between Japan and the US, as well as between the yen and other currencies, remain at a high level," she noted, which reduces the likelihood of large-scale unwinding of arbitrage trades.

This confidence stems from the optimization of the Bank of Japan's communication mechanism: since the unexpected interest rate hike in July last year triggered market turbulence, the central bank has begun arranging for policy committee members to give scheduled speeches and hold press conferences before monetary policy meetings. For example, ten days before the interest rate hike this January, Deputy Governor Ryozo Himino clearly released policy signals, and Governor Kazuo Ueda subsequently reiterated that the final 25 basis point hike (the largest in 18 years) was fully digested by the market, with bank stocks leading the way to push the stock index upward.

Mitsubishi UFJ Asset Management Chief Fund Manager Masayuki Oguchi stated: "The rate hike in January proves the continuity of the central bank's policy, and the market can now more clearly anticipate the rate hike path." Meanwhile, the Japanese stock market has shown greater resilience after experiencing a collapse last summer and tariff shocks in April this year. Smithers pointed out: "The two flash crashes have cleared some speculative funds, and the remaining bulls are more confident in the Japanese market."

Foreign capital continues to flow into the Japanese stock market, driven by corporate buybacks and governance reforms. M&G Japan Equity Investment Director Sunny Romo emphasized that the reforms aimed at enhancing shareholder returns and releasing long-term value by listed companies are far from over, providing attractiveness for global investors seeking diversified allocations.

On the domestic policy front, the market is anticipating that the ruling party may compromise to reduce the consumption tax following recent elections, which is heating up expectations for retail and other domestic demand sectors. Phillip Securities Research Director Kazuhiko Sasaki believes: "If fiscal expansion policies are implemented, domestic demand-driven stocks will welcome a catalyst."

Goldman Sachs and Bank of America Securities recently raised their target prices for the Nikkei 225 and TOPIX indices, believing that a U.S.-China tariff agreement controlled within 15% will alleviate pressure on Japanese exports. However, the yen's movement remains a key variable. Intalcon Asset Management CEO Klaus Wobbe warned that trade friction clouds and the stability of Prime Minister Shigeru Ishiba's administration may increase demand for yen as a safe haven: "If the Federal Reserve cuts rates in the fourth quarter while the Bank of Japan continues to tighten, the yen may return below the 140 mark, which will be an important test of market resilience." The current exchange rate level is becoming a new barometer for observing global capital flows