Episode Details

Our four-person panel explains Japan’s economic boom, from growing GDP to corporate sector vibrancy, and which upward trends will sustain.

----- Transcript -----

Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Japan is undergoing a once in a generation transformation. A country once associated with its lost decades is now seeing multi-decade highs for nominal GDP growth and equity indices.

On this special episode of the podcast, we will discuss why we are so optimistic on Japan's trajectory from here. I'm joined by our Chief Japan Economist Takeshi Yamaguchi, our Chief Asia and EM Strategist Jonathan Garner, and our Japan Equity Strategist Sho Nakazawa.

This episode was recorded last Friday, May 31st at 9 am in Hong Kong.

Jonathan Garner: And 9 am in Singapore. 

Takeshi Yamaguchi: And 10 am in Tokyo. 

Chetan Ahya: Japan's nominal GDP growth reached a 32 year high in 2023. Equity markets have reached multi decade highs, and ROE and productivity growth have been on an improving trend. Corporate sector vibrancy is returning, and animal spirits are reviving. A new, stronger equilibrium is one of robust nominal GDP growth and a sustainable moderate inflation.

This new equilibrium of stronger normal GDP growth and low real interest rates will also be supportive of Japan's capex trends. With that backdrop, let me now turn to Yamaguchi san. 

Yamaguchi-san, what makes us confident that this virtuous cycle of rising wages and prices will continue to play out?

Takeshi Yamaguchi: We think Japan's social norm of no price hike, no wage hike is changing, and a good feedback loop between wages and prices is emerging. Workers demand higher wages with higher inflation expectations and the corporate management accept their demand, as they also expect higher inflation. Japan's labor market remains structurally tight and aggregated corporate profits are now at a record high level. In addition to the pass-through from prices to wages, we are beginning to see the pass-through in the other direction from wages to prices, especially in service prices. 

The average wage hike in these spring wage negotiations was the highest in the last 33 years. So, we expect to see a gradual rise in service inflation going ahead with a rise in wages. 

Chetan Ahya: Could you elaborate a bit on the details of the capex outlook? 

Takeshi Yamaguchi: Yes. We expect Japan's private capex to exceed its previous 1991 peak this year. In the previous deflationary period, domestic nominal GDP remained in a flat range, and Japanese firms mainly invested abroad. That said, the trend of Japanese nominal GDP growth has shifted up, which will likely positively affect Japanese firms’ decision to increase domestic investment.

Also, there are various other factors supporting domestic capex, such as real interest rates remaining low, the weak yen, the government's new industrial policy supporting onshoring and semiconductor investment, and the need for digitalization and labor-saving investment on the back of structural labor shortage driven by demographic shifts.

Chetan Ahya: Thank you, Yamaguchi-san. And, you know, I can't let you go without answering this question, which is much of the focus of the markets right now. If yen depreciates to 160 again, how much upside risk to your rate path do you see?

Takeshi Yamaguchi: Our FX team expects the yen to gradually appreciate to 146 by the end of 2024, and under the assumption, we expect one hike this year in July and another one in January next year. However, if sustained yen depreciation raises domestic underlying inflation trend, we think the BOJ will respond by raising the policy rate further to 0.75 per cen