Outlook for Global Markets and Japan-US Monetary Policy

The Importance of Hedging Strategies and Money Flows in a Goldilocks Scenario

In the current environment, the interplay between risk-on sentiment and monetary policy expectations is shaping a ‘Goldilocks1’ scenario – where conditions are just right to support a robust performance in risk assets. 

Key market drivers 

•    US economic strength fuels risk appetite: The US economy remains resilient, underpinning a strong risk-on market sentiment. Concerns about an economic slowdown are easing, which supports continued confidence in the stock market.
•    Expectations of monetary easing to curb inflation is increasing, but risks are also rising: With the US economy performing strongly and inflation remaining stable, the possibility of the Federal Reserve System (Fed) lowering interest rates is increasing. However, there is a risk that stocks and bonds will fall simultaneously due to market overheating, a worsening economy, and persistently high inflation. Therefore, the implementation of hedging strategies is recommended.

Changes in money flows

•    Foreign investors remain confident in Japanese stocks: The recent rise in the Japanese stock market is largely driven by factors unique to Japan. Overseas investors are evaluating Japan's structural changes, which have led to stronger foreign investment inflows into Japanese equities.
•    European investors increase USD hedging: Although the market is pointing out the risk of ‘decoupling’ from the US, there has been no significant change in capital flows into US Treasuries. However, hedging of the US dollar has increased, particularly among European investors, contributing to a weaker dollar and a stronger euro.

Japan-US Monetary Policy and Interest Rate Outlook

US: Employment data increases likelihood of a September rate cut
Since inflation rates and corporate profit margins are stable, combined with softening employment data,  the likelihood of a rate cut by Fed in September has increased. However, if the labor market shows renewed strength, the Fed may pause further cuts, signaling a more cautious approach. 

Japan: Interest Rate Hike Expected in October 

We expect the Bank of Japan to raise its policy interest rate to 0.75% in October, with further increases anticipated every six months thereafter. Factors influencing this outlook include: 
•    Even if the Fed cuts interest rates in September, a potential recovery in the US labour market makes it unlikely that the US economy will deter the Bank of Japan from raising rates. 
•    The current inflation rate indicates that price pass-through effects on goods and services are gradually, alongside increasing long-term inflation expectations. 
•    Although the agreement reached in the Japan-US tariff negotiations resulted in some tariff hikes, the negative impact on GDP was reduced by about 0.2% if the spillover effect on automobiles is included. In addition, with other major countries also reaching agreements, the reduction in uncertainty may boost capital investment and next year's annual wage negotiations. 
•    The upcoming autumn economic stimulus package, which may include a one-time cash disbursement and efforts to abolish the provisional gasoline tax, is expected to support domestic demand.
•    Some have pointed out that it would be difficult to announce economic measures while also raising interest rates. However, delaying a rate hike could risk overturning the agreement reached in the Japan-US tariff negotiations, which might have an even more negative impact on the Japanese economy.

For more details, please refer to the research reports below: 
Jin Kenzaki: Is the BoJ moving slightly closer to an October rate hike?
Tsutomu Saito: Impact of Japan-US 15% Tariff Deal on Japanese Stocks Amid Exchange Rate Uncertainty

_{1. Goldiloks economy: an economy that is growing at an even rate and is not at risk of high inflation or recession.}