Japanese equities have fallen out of favour with foreign investors over the past four years, since the initial euphoria of Abenomics faded (top-left chart). This has contributed to Japanese equities’ relatively low valuations, with the Topix becoming increasingly undervalued relative to the S&P 500 (top-right chart). The prevailing narrative is that Japan’s monetary policy is becoming impotent, with Japanese yield curves flattening towards zero and the BoJ tapering asset purchases (bottom-left chart) as its balance sheet has surged to above 100% of GDP.

However, equity inflows could return if the BoJ ends up following the ECB’s example and reengaging in more monetary policy easing. With the ECB last month and Trump’s attempts to step-up pressure on the Fed, the central-bank easing tug-of-war appears to be returning. The BoJ is also facing a moribund economy where inflation surprises have collapsed (last chart), growth remains weak and M1 growth is slowing again, which will put increasing pressure on the BoJ to act.  The latest salvo from the ECB is another reminder the BoJ will need to act soon.

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Source: Bloomberg, Macrobond, Variant Perception