The futures contract on Japan’s Nikkei 225 index is breaking out bullishly from a three-week stagnation, in response to the overnight announcement of a trade agreement between Japan and the U.S. (JP225: +3.7%). Optimism is spreading across other Asian markets, though fading trade uncertainty is once again highlighting Japan’s political and monetary challenges.
At the end of June, as US-Japan trade relations deteriorated, the Nikkei 225 dropped nearly 3% from its local high around 40,800 and became range-bound between 39,320 and 40,130. The contract is now trading at a 1-year high. Source: xStation5
Awakening in Tokyo
The consolidation observed on the Japanese stock market in recent weeks stemmed from the “uncertainty from all sides.”
On one hand, Donald Trump suddenly escalated tariff rhetoric toward Japan (raising tariffs from 24% to 25%)—an economy already teetering on the edge of stagflation, even without tariffs. On the other, the upcoming parliamentary elections weighed on sentiment, and as feared, they weakened the ruling party, resulting in a minority government and domestic instability.
The removal of trade uncertainty was enough to awaken the bulls in Tokyo. On Truth Social, Donald Trump announced that the tariff rate on Japanese goods will be 15%, including automobiles, which had been most vulnerable to falling sales due to tariffs.
Currently, only 12 stocks in the entire Nikkei 225 are in the red, and the rally is led by Japanese carmakers (Mazda: +17.7%, Toyota: +14.3%, Honda: +11.1%). Optimism also spread to Seoul (Kia: +8.5%, Hyundai: +7.5%).
Internal Uncertainty Gains Weight
However, the euphoria is laced with uncertainty. Following Sunday’s elections, Prime Minister Shigeru Ishiba’s party lost its majority in the upper house, securing only 47 out of 50 required seats. Despite previous statements, Ishiba announced his resignation today.
The resulting political instability has already contributed to a depreciation of the yen, halting its recent temporary strengthening. A weaker yen increases the cost of imported goods, and when combined with political pressure to support consumer spending—especially amid high food prices—this puts the Bank of Japan (BOJ) in a difficult position.
BOJ policymakers announced today that they will resume interest rate hikes, ending the pause during the trade uncertainty period. However, the real policy rate remains below zero, and the BOJ estimates that reaching a neutral rate would require an additional 100 basis points hike (current rate is 0.5%).
A rebound in Japanese bonds has slightly slowed the upward trend in USDJPY. Source: XTB Research
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