Japan’s Record Nikkei Tests Policy Nerve

Japan’s equities punched through a psychological ceiling as the Nikkei 225 vaulted above 50,000, powered by expectations of sizeable fiscal stimulus and corporate balance-sheet reform. The rally coincides with a softer yen and a renewed global risk bid after signs of a U.S.–China trade thaw. Mechanically, three levers did the work. First, multiple expansion: earnings revisions have been modest, but the index’s forward P/E compressed earlier in the year and is now re-rating as domestic policy signals firm.

Second, currency translation: with USDJPY elevated, exporters’ yen revenues translate more favourably, widening operating margins even before volume effects. Third, capital discipline: buybacks and cross-shareholding unwinds continue to lift return on equity, a shift investors increasingly price as structural rather than cyclical.

Macro conditions remain supportive but tight. Headline CPI has eased from its 2024 peaks, yet core pressures and administered energy adjustments keep real policy rates near zero. Ten-year JGB yields have firmed but remain well below U.S. Treasuries, sustaining a relative carry that caps the yen’s rebound. The external backdrop is mixed: oil’s drift (CL=F) tempers import costs, while a steady dollar (DXY) constrains broad Asia FX. Domestically, capex intentions in autos, electronics and machinery hint at a late-cycle investment push provided credit conditions do not tighten abruptly.

Markets have reacted accordingly: cash equities saw broad breadth, with cyclicals and financials leading; defensives lagged as risk premia compressed. Credit spreads barely moved, reflecting limited incremental leverage. Forward risks cluster around policy sequencing. A stimulus package that leans too heavily on consumption vouchers risks transience; more durable supply-side support—energy transition capex, data-centre infrastructure and semiconductor equipment—would lock in productivity gains. The Bank of Japan’s glidepath must balance yield-curve stability with exit credibility; an abrupt JGB sell-off would test equity multiples via higher discount rates.

The forward read: watch three indicators. First, wage settlements at spring shuntō; a sustained 3–4% print would anchor real income growth. Second, USDJPY’s range—sustained moves below 145 would tighten financial conditions via equity translation. Third, external demand proxies—semiconductor equipment orders and auto export volumes—will define earnings durability into 2026. For now, positioning and policy alignment keep the uptrend intact, but valuation sensitivity to rates argues for measured exposure and tight risk controls.