Source: Golden Ten Data

The Japanese stock market is booming, but the Bank of Japan's first rate hike since 2007 could hurt it. Although withdrawing from the negative interest rate policy is a sign that policymakers are confident in the Japanese economy, interest rate hikes may also affect investors' bets.

After much hard work, Japan finally escapes deflation

In the early 90s of the last century, after Japan's asset bubble burst, the Japanese economy entered a race to the bottom: land prices, stock prices, and interest rates fell again and again. As economic growth stagnated and fell into deflation, the Bank of Japan tried a series of policies to promote economic growth and price recovery, and eventually introduced a negative interest rate policy in 2016, making commercial banks have to pay interest on any excess reserves left at the central bank. The Bank of Japan hopes that through this approach, the banking industry can be forced to make better use of these funds to help stimulate the economy.

The effectiveness of this policy remains to be discussed. Although negative interest rates and quantitative easing helped weaken the yen and prevent deflation from intensifying, it wasn't until the COVID-19 pandemic and Russia-Ukraine conflict impacted the supply chain that the inflation rate climbed above 2% and remained at this level.

The recovery in inflation is driving the long-awaited recovery in the stock market. The Nikkei 225 index rose about 18% this year, far higher than the 7.3% increase in the S&P 500 index. Meanwhile, the yen remains at a 33-year low against the US dollar.

Japanese policymakers are preparing to raise interest rates for the first time since 2007, although the rate hike is still pending at the March or April meetings. Stronger wage growth will herald the beginning of an inflationary cycle, which will give the central bank greater confidence to raise interest rates.

How to welcome the Bank of Japan's interest rate hike?

Alina Fisch, founder of Contessa Capital Advisors in New York, believes that buying a stock ETF is the easiest way to bet on Japan's economic recovery. On the one hand, the operation is simple and the cost is low. On the other hand, this is generally safer than choosing a Japanese company, and you won't fall into the trap of investing in a specific Japanese company.

Currently, the biggest ETF betting on the Japanese market is BlackRock's iShares MSCI Japan ETF. Its price has risen 8.5% so far this year, and revenue is nearly $1.4 billion, according to data collected by Bloomberg.

However, betting on the Japanese stock market is currently facing some risks. One of the biggest dangers is that interest rate hikes may inhibit economic growth and weaken the stock market's rebound.

Wolfpack Wealth Management Managing Director Leyder Murillo said

If interest rate hikes cause the yen to appreciate, growth-oriented companies are particularly likely to face challenges as it will make their products more expensive overseas. However, companies that mainly import or focus only on the domestic market may benefit. Investors should consider equity investments in companies that are expected to benefit from a stronger yen.

Despite this, the long-term trend of the yen is not guaranteed. This makes it more difficult for overseas investors because they have to exchange their local currency for yen to invest in Japan and then exchange it back when they close their positions.

In recent years, as the dollar appreciated against the yen, it took more yen to buy back the same amount of dollars when selling Japanese stocks. This has been dragging down returns.

Craig Toberman, Toberman Becker Wealth Partner, said:

If you're unsure about future exchange rate relationships, or just don't want to risk it, currency hedge funds would be a purer choice.

Editor/jayden