Prime Minister Shinzo Abe’s resignation after eight years in office owing to ill health sharply affected investor sentiment in Japan late on Friday. The Nikkei 225 fell 1.4% and the JPY - favoured as a safe-haven during times of uncertainty - jumped from 106.50 to 105.40 against the USD.
Japan’s longest serving leader provided much needed political stability when he came to office for a second time as premier in September 2012 - after the country had experienced six prime ministers in the preceding six years.
Abe’s policies of fiscal stimulus with sales tax rises, quantitative easing under Bank of Japan (BoJ) Governor Kuroda and structural reforms - dubbed Abenomics - helped end the deflation Japan had suffered in its ‘two lost decades’ after its stock market bubble burst at the end of 1989.
In addition, Abe’s corporate governance reforms spurred the Nikkei to almost treble during his tenure. Thus, investors turned risk-seeking and shunned the JPY. The currency fell from 77 against the USD in 2012 to as low as 125 in 2015 - to the benefit of Japanese exporters.
The ruling Liberal Democratic Party (LDP) will now hold an internal contest to find Abe’s successor. The continuity candidates - Cabinet Secretary Yoshihide Suga, Finance Minister Taro Aso and LDP policy chief Fumio Kishida - will keep Abe’s market-friendly policies. The one candidate with a more populist agenda - former defence minister Shigeru Ishiba - appears to have few supporters amongst LDP members of parliament.
Thus, the risk from a shift in economic policy under a new prime minister seems low. A surge in the safe-haven JPY, however, owing to sudden political uncertainty may be the greater threat to Japan’s stock markets in the near term.
First, the USD has already been falling over the summer and Japan’s weak currency has the scope to rise much further - having lost 22% of its value in real, trade-weighted terms since 2010. A stronger currency would adversely affect Japanese exporters’ competitiveness.
Second, Abe’s lengthy tenure gave Japanese corporates the confidence to buy foreign companies to boost their long-term growth prospects. If local firms lose their risk-taking appetite now for overseas acquisitions the JPY will rebound again.
Third, the authorities in Tokyo will not intervene in the currency markets to stop a surge in the JPY towards 100 against the USD given opposition from the Trump administration and other G7 countries to exchange rate manipulation.
Last, the BoJ could act to stop JPY strength by lowering its deposit rate from -0.10% but deeper negative interest rates would hurt Japanese financial institutions’ profits.
Thus, the risk of a sudden surge in the JPY to 100 against the USD - rather than a shift in economic policies - seems to be the main threat to Japan’s domestic markets in the near term from Abe’s unexpected resignation on Friday.Disclaimer applicable to recommendation
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