Will Japan Win Or Lose Under Trump 2.0?

The same goes for fiscal excesses putting the global financial system in jeopardy. As Sobel puts it:“Public debt is high in the US, much of Europe, Japan and China. In the US, the fiscal trajectory is unsustainable. Trump is likely to boost deficits from the already absurdly high level of 7% of GDP, pushing up longer-term rates, hurting investment and causing market indigestion. Will bond vigilantes return?”

This puts the BOJ in a particularly tough position. Hitoshi Asaoka, senior strategist at Asset Management One, adds that“if the Japanese economy is negatively impacted by the US tariff increase without a corresponding depreciation of the yen, it is possible that the BOJ will delay the rate hike and keep the policy unchanged for a while.”

Frank Benzimra, head of Asia equity strategy at Societe Generale, notes that“in the coming months, the equity markets look set to be shaped by China –the extent of fiscal support – the US – the dollar, trade, diplomacy and the Bank of Japan – the potential catalyst for carry-trade unwinding – policies. The outcome will not necessarily be bearish.”

Indeed, optimism abounds in Japanese corporate circles. Nearly 80% of Japan's top firms think the domestic economy will continue to expand in 2025 as wage hikes boost consumer spending, a Kyodo News survey funds.

But markets will be hard-pressed to adjust to every zig and zag.“Markets will be quite volatile but without much significant net direction, as the perceived odds of these different [tariff] scenarios oscillate,” says Phil Suttle, principal at Suttle
Economics.

That goes, too, for central banks from Tokyo to Washington.“Looking ahead to 2025, a substantial degree of central bank easing is already priced into most rates markets, while credit spreads have tightened in recent months and are currently relatively narrow by historical standards,” says Daniel McCormack, head of research at Macquarie Asset Management.

This, McCormack adds,“limits the upside in terms of returns for bonds, and equity asset classes are likely to benefit more from the macroeconomic environment that we expect to see in 2025. That said, yields have improved significantly in recent years, and absolute returns in 2025 should be healthy by historical standards.

“Following clear signals from central bank officials that further easing is likely, bond markets have moved to price in aggressive easing cycles by most major central banks in the coming quarters – with the notable exception of the Bank of Japan , for which further hikes are priced.”

As such, many BOJ watchers still think it's full speed ahead for rate hikes. Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG, says,“we retain our base-case forecast of a rate hike in January.”

BOJ Governor Kazuo Ueda recently said that“if economic activity and prices continue to improve, [the BOJ] will accordingly need to raise the policy interest rate and adjust the degree of monetary accommodation.”

And that“uncertainties with regard to the economic policies of the incoming US administration” and“how the annual Spring labor management wage negotiations will develop” will have the final say on Japanese rates.

Izumi Devalier, an economist at Bank of America, says that Ueda's comments“gave a stronger indication that the central bank may need to wait until at least the March
monetary policy meeting to gain
sufficient information
to make the judgment for a hike.”

With a BOJ rate hike unlikely until March at the earliest, says Tony Sycamore, market analyst at IG Australia,“the risk of dollar-yen testing extending its rally towards 160/162 in early 2025 remains elevated” from 157 now.

By the end of 2025, Asaoka anticipates that the BOJ will raise the policy rate to 1%,“which is considered the neutral rate.” He adds that“if the Trump administration's policies lead the Federal Reserve to pause rate cuts in 2025, the BOJ will find it relatively easier to proceed with rate hikes.”

That scenario has some investors betting on the good times returning for Japanese stocks.

“We expect the Nikkei 225 will reach 45,400 and TOPIX to 3,190 by the end of 2025” from 39,190 now, says Hisashi Shiraki, strategist at Sumitomo Mitsui DS Asset Management.

He adds that“although foreign investors' appetite for Japanese stocks appears sluggish, a massive amount of share buybacks, as much as 17 trillion yen in fiscal year 2024, could protect the downside and boost the stock market going forward.”

There's an argument, too, that Japan Inc could benefit from deeper troubles being suffered elsewhere, says Junichi Inoue, head of Japanese equities at Janus Henderson Investors.

“Due to Japanese stocks' comparatively low valuations versus global equities, and ongoing governance reforms contributing to return-on-equity improvements, we expect the market to demonstrate a certain level of resilience,” Inoue says.

Inoue also notes that“for these reasons, we believe Japanese equities can be considered an attractive risk-reward asset class, deserving of an allocation in a diversified portfolio, particularly those companies that are exposed to global markets and global growth .”

Yet global risks could deflate such views. Though Trump's threatened trade war is aimed at China, Japan would take considerable economic shrapnel – perhaps even more in certain ways. For all China's challenges, Xi Jinping's team has been busily diversifying exports to Global South economies around the globe.

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Shunsuke Kobayashi, chief economist at Mizuho Securities, acknowledges hope that Trump's proposed tax reductions will offset the tariffs risks and boost profits for Japanese firms with heavy US exposure. But either way, a giant trade war would slam Japan's gross domestic product .

“If that happens, capital investment would decline due to expectations that exports will drop, eventually negatively affecting the broader economy,” Kobayashi says.

That could leave Japan Inc even less inclined to raise wages. Japan has been slower to pivot away from the American consumer. Signals that the Fed won't be cutting rates as rapidly as hoped are hardly welcome in Tokyo.

Indeed, the Trumpian headwinds to come make 2025 a perilous time for Japan. The BOJ confirmed as much last month when it opted against hiking rates. Ahead of that December 19 decision, traders were primed for Ueda to tighten. Many felt its refusal to act smacked of fear, not pragmatism.

Last week, traders pushed 10-year yields above 1.1% for the first time since 2011 , a clear signal markets think the BOJ erred by not hiking.

“It's like the rug was pulled out from under us,” Kazuhiko Sano, chief bond strategist at Tokai Tokyo Securities, tells Nikkei Asia.

If the BOJ doesn't think Japan is ready to take off the financial training wheels, why should corporate chieftains and global investors?

Granted, there are valid reasons to bet on cash-rich Japan Inc companies raising their governance game. Japan, after all, has carved out a place for itself as an Asia-region safe haven as deflation plagues China.

There comes a time, though, when investors look at the underlying economy and wonder if policy changes are keeping pace with the degree of optimism coursing through markets.

As more and more investors search for an answer, a dearth of household demand may give all too many investors pause about Japan's chances in the Trump 2.0 era.

Of course, surprises are always possible. Perhaps Ishiba will suddenly find his reformist sea-legs and cling to power on elections being mulled for July .

Maybe Trump will prioritize a trade deal with Xi's China over a tariff arms race. Or maybe the President-elect will give ally Japan preferential market treatment while punishing adversary China.

But as a highly uncertain year begins, Japan's past could catch up with it just as Ueda's BOJ and Ishiba's LDP stumble in the present.

Follow William Pesek on X at @WilliamPesek

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