Nikkei 225 Opens Higher
No Sharp Outflow of Foreign Capital
Caution Against Market Optimism
Shigeru Ishiba, Prime Minister of Japan and President of the ruling Liberal Democratic Party. Photo by EPA Yonhap News
Despite the shock of the ruling party's crushing defeat in the House of Councillors election, the Japanese stock market opened higher on July 22, buoyed by the strong performance of the U.S. stock market overnight. There was no sharp outflow of foreign capital, but market participants are warning that optimism is unwarranted.
As of 9:10 a.m. on this day, Japan's benchmark Nikkei 225 index (Nikkei Stock Average) rose 0.91% from the previous session to 40,180.80. After a sluggish trend since July 1, the index has been rebounding since July 11. On the same day, the TOPIX index, which reflects all stocks on the First Section of the Tokyo Stock Exchange, also rose by 0.78%. The Japanese stock market was closed on July 21 for the public holiday "Marine Day." The dollar-yen exchange rate also fell to 147.47 yen, with the yen turning stronger after two consecutive weeks of declines.
The record-breaking rally in the U.S. stock market overnight appears to have spread positive sentiment across Asian markets. In addition, the resolution of political risk, regardless of the House of Councillors election results, further boosted stock prices. Mark Dowding, Chief Investment Officer (CIO) at RBC BlueBay Asset Management, told the Nikkei newspaper that "although the election results were unfavorable for the Liberal Democratic Party, the market had already priced in much of this."
The Nikkei newspaper pointed out that the absence of a sharp outflow of foreign capital is because investors see the likelihood of a pessimistic scenario materializing as low. Such scenarios include a sharp rise in long-term interest rates and a downgrade of government bond credit ratings due to fiscal risk, as well as a simultaneous slump in the yen and Japanese stock market. The fact that the Liberal Democratic Party, despite failing to secure a majority, remains the largest party in both the House of Representatives (lower house) and the House of Councillors (upper house) also acted as a safety net.
Joel Rousseau, Japanese equity portfolio manager at Eurizon Capital, commented, "The opposition parties advocating a consumption tax cut are still not a powerful force with enough competitiveness to form a government," adding, "The possibility that a full-fledged debate on consumption tax cuts will lead to market turmoil, yen weakness, and a rise in long-term interest rates remains at the level of a 'tail risk.'" Tail risk refers to a risk that has a very low probability of occurring but can have a massive impact on the economy or society if it does happen.
There are also counterarguments that the burden of Japan's expanding fiscal deficit should not be overlooked. Prime Minister Shigeru Ishiba prioritized fiscal consolidation, and this policy stance is being cited as a reason for the defeat in the House of Councillors election. Claire Fan, macro strategist at Amundi Asset Management, pointed out, "The election results indicate that the government is politically constrained from taking substantial fiscal consolidation measures," and added, "Given that the government debt-to-GDP ratio is extremely high and the Bank of Japan, the largest buyer of government bonds, is retreating from quantitative easing, optimism is unwarranted."
If the debate on a consumption tax cut, supported by the opposition parties, gains momentum, long-term interest rates are expected to trend upward. Miki Kiyotomo, executive officer at Taiyo Life Insurance, forecast, "Within the next month, long-term interest rates could exceed this year's high of 1.61% and rise to 1.65%."
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