Why we’re staying bullish on the Japanese Yen in 2025

In the third quarter of this year, the Japanese yen (JPY) staged a stunning rally, appreciating 12% against the US dollar. Expectations of aggressive Fed easing, combined with the Bank of Japan's rate hike in July, drove the yen to its strongest levels since 2023 by mid-September. Consequently, JPY was the top-performing major currency in 3Q24 (Figure 1).

Figure 1: Major currency performance in 3Q24

After an impressive rally, the yen has retreated once more. The initial reversal occurred following Shigeru Ishiba's election as leader of Japan’s ruling party. Upon taking office as Japan's new Prime Minister on 1 October, Ishiba unsettled currency markets by stating that the economy is not yet ready for another interest rate hike from the central bank. This statement nudged the yen back to the 150 range (Figure 2). The Liberal Democratic Party’s (LDP) failure to secure a majority in parliament during the general elections, coupled with Trump’s re-election, further extended the yen’s decline.

Figure 2: The JPY has retreated once more

Japan is keeping a close eye on yen weakness

With the USD/JPY hitting one of the highest levels in months, Japan’s top currency official Atsushi Mimura (who assumed the position from Masato Kanda in June) has intensified verbal warnings. Mimura emphasised that authorities are closely monitoring market movements and stand ready to take appropriate actions against excessive volatility. He noted that movements in the currency market have been abrupt and one-sided, suggesting that the recent yen weakness was driven more by speculation than by underlying fundamentals.

This year, Japan has taken bold action, spending over than JPY 15 trillion intervening in foreign exchange markets to stabilise the yen (Table 1). That said, the nation still holds USD 1.24 trillion (approximately JPY 192 trillion) in foreign currency reserves, the second highest in the world after China (Figure 3). This formidable financial buffer strengthens Japan's position to defend the yen as necessary.

Table 1: Yen intervention in 2024

Period of Disclosure	Intervention Amount	Yen’s Low	Yen’s High
26 April - 29 May	JPY 9.8 trillion	158	153
27 June - 29 July	JPY 5.5 trillion	162	154
Source: Ministry of Finance, Bloomberg Finance L.P. Data as of October 2024

Figure 3: Japan has a large foreign currency reserve, only behind China

Further interventions are plausible, as the stakes are far too high for Japan to back away. A major concern for policymakers is the risk of rising imported inflation. A weaker yen drives up import prices which could potentially erode household purchasing power, offsetting wage gains that Japan has longed for. Moreover, cost-push inflation driven by currency depreciation is not the type of inflation the BOJ is targeting. The central bank aims for sustainable inflation driven by domestic demand which can support a positive growth cycle where wage growth consistently outpaces inflation.

Hence, should the yen weaken further, authorities may take decisive action to defend the currency. As Japan moves towards a more normalised monetary policy while other major central banks have started easing, we believe any intervention now would likely have a more pronounced impact than before.

Fundamentals remain supportive of yen appreciation

After the currency markets’ knee-jerk reaction, PM Ishiba has since softened his stance. His recent remarks suggest a more pragmatic approach, aligning with BOJ Governor Kazuo Ueda’s view that there was time to assess the situation in markets and the economy before making any changes to rates. This signals the need for a cautious path towards further rate hikes, rather than ruling them out altogether. On another positive note, we believe the BOJ will retain autonomy in setting monetary policy, ensuring continuity regardless of Japan’s government changes.

While the BOJ maintained interest rates in the 31 October meeting, it is reassuring to see that the central bank has signalled that conditions are falling into place to raise rates again. Among the key points cited were that external risks such as those surrounding the US economy were somewhat subsiding, and wages and prices in Japan are expected to align with BOJ forecasts in the coming years (Table 2). As of October 2024, Japan's core inflation has consistently remained at or above the BOJ’s 2% target for over two years, underscoring the country’s progress toward sustainable inflation.

Table 2: BOJ median forecasts

Fiscal Year	Real GDP	Core CPI	Core-Core CPI
2024	0.6%	2.5%	2.0%
2025	1.0%	1.9%	1.9%
2026	1.0%	1.9%	2.1%
Core CPI: all items less fresh food Core-Core CPI: all items less fresh food and energy Data as of 31 October 2024

Meanwhile, Japan's largest labour union group Rengo announced it will seek wage hikes of at least 5% in 2025, similar to this year's hefty increase of 5.1%. Rengo also stated it will focus on securing higher wage increases at smaller firms, setting a target of at least 6% to help narrow the income gap with workers at large companies. This outlook provides impetus for the BOJ to continue raising borrowing costs as the economy sustains a moderate recovery, and perhaps more quickly than what the market currently anticipates.

At present, the market has priced in only one additional rate hike by March 2025, reflecting cautious expectations despite the BOJ stating that economic conditions are steadily aligning for further tightening (Figure 4). As such, if rate hikes come more rapidly, the yen could experience further upside.

Despite some volatility stemming from political developments, the underlying drivers of a yen appreciation remain intact. Japan’s economy is experiencing a gradual recovery, inflation appears to be sticky, and the BOJ has signalled that it could further raise rates. With many other major central banks on their cutting cycles, the policy divergence is poised to narrow the yield differential between the BOJ and foreign central banks, resulting in a gradual appreciation of the JPY over the longer term (Figure 5).

Figure 4: Market expectations for rate hikes are fairly conservative

Figure 5: A narrowing of yield spread should drive JPY appreciation

Earnings of leading Japanese companies are expected to remain resilient

Investors may worry that a stronger yen could impact the outlook for the Japanese stock market. As the earnings season unravels, we take a closer look at the latest results and guidance from the top three constituents of the Nikkei 225: Fast Retailing, Advantest, and Tokyo Electron which together represent about 23% of the index.

Fast Retailing (~11% of index) – Consumer Discretionary

The parent company of Uniqlo, Fast Retailing, reported a record-high performance in its latest financial year ended August, beating its own estimates. Consolidated revenue rose 12.2% year-on-year to top JPY 3 trillion for the first time, while profit attributable to owners of the parent expanded 25.6% to JPY 371.9 billion. Rising brand awareness across the globe helped fuel the extremely strong performance. Notably, driven by its global expansion strategy, Uniqlo International achieved a remarkable 19.1% increase in revenue. Full year same-store sales in most regions also rose year-over-year.

The management predicts 9.5% and 3.5% year-on-year increases in revenue and profit attributable to owners of the parent respectively in FY2025 to fresh record-high levels. They highlighted that overseas operations, led by Uniqlo International, would experience robust growth in FY2025. These come even as the foreign exchange rates used in the business estimates assume an appreciation in the yen to 140 per US dollar.

We note that yen weakness is a double-edged sword for Fast Retailing. On one hand, it could amplify overseas revenue, which accounts for a substantial 60% of the company's overall revenue. On the other, it could constrain domestic profit margins due to higher merchandising and procurement costs. We believe investors should look beyond short-term currency fluctuations and focus on the fundamentals driving Fast Retailing’s growth. With a strong global brand anchored in quality and innovation, coupled with a well-executed global expansion strategy, Fast Retailing is well-positioned to sustain its positive earnings momentum moving forward.

Advantest (~6% of index) – Technology

In the three months ending September, the world’s biggest supplier of chip testing equipment Advantest reported a near two-fold increase in net income, achieving a record high for the quarter, driven by robust tester demand for high-performance semiconductors used in AI. Due to a better product mix, gross profit margin also increased to 57.8% from 49.9% in the previous year.

While the management has assumed a stronger yen against the US dollar of 140 for the next six months, full year guidance has still been revised upwards with an estimated basic EPS growth of over 90% (excluding the effect of share repurchases). Robust tester demand for HPC/AI-related semiconductors is expected to continue as chips continue to grow in importance within the global economy. In response to robust demand, Advantest is also strengthening its tester supply capabilities.

Tokyo Electron (~6% of index) – Technology

In the three months ended September, Tokyo Electron delivered a 60.9% year-on-year increase in net income on the back of strong AI-related demand. Like Advantest, the company has upwardly revised its estimates for the full year ending March 2025. It now expects net income per share to increase by 45% y-o-y, riding on stronger sales in memory-related semiconductor production equipment.

It is worth noting that Tokyo Electron denominates its export sales in Japanese yen. As a result, exchange rate fluctuations tend to have a negligible impact on its revenue and profits.

Remain positive on both JPY and Japan stocks

Overall, it appears that corporate earnings in Japan are poised to remain resilient even in the face of potential yen strength, thanks to the global competitiveness of the country’s leading companies and powerful megatrends like AI and digitalisation. What makes Japan compelling is also that its growth narrative is rooted in structural factors rather than cyclical ones, paving way for a sustained multi-year rally. With the ongoing shift towards inflation gaining traction and ongoing reforms focused on enhancing capital efficiency, Japan’s structural transformation remains firmly in place. This reinforces our optimistic outlook for the Japanese stock market. We maintain our target price of 48,000 for the Nikkei 225 Index which translates into an attractive upside potential of 25%.

Table 3: Nikkei 225 earnings forecast

Nikkei 225 Index	FY23	FY24	FY25	FY26
PE Ratio (X)	26.1	21.2	18.0	16.0
Expected Earnings Growth	(10.4%)	41.2%	17.8%	12.4%
Earnings Per Share (EPS)	1,284	1,813	2,135	2,400
Target Price (Based on fair PE ratio of 20X)				48,000
Potential Upside (%)				25.1%
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 28 November 2024

Meanwhile, the yen is too cheap to ignore. Japan’s real effective exchange rate (REER), which measures the value of the yen against its peer average adjusted by consumer prices, remains at one of its lowest readings since data inception in 1970 (Figure 6). With improving economic fundamentals in Japan bolstering the case for rate hikes and narrowing yield differentials, we anticipate the yen will strengthen in 2025. While it may not have emerged as a top performer this year, our conviction in its potential remains strong.

(Related article: Japanese Yen will be one of the top performing currencies in 2024)

Figure 6: The yen is very cheap

We recommend investors to continue accumulating Japanese equities and to maintain exposure to the yen through an unhedged share class. This way, any appreciation of the yen would contribute to the total returns received by investors. Our recommended products to gain access to Japan’s equity market are the Eastspring Investments - Japan Dynamic AS SGD and the Xtrackers Nikkei 225 UCITS ETF 1D (LSE:XDJP).

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.