Japan, as the 4th-largest economy in the world has several strengths and weaknesses. Japan's labour market and corporate sector are and remain solid. But the country is facing an rapidly ageing population and a loss of purchasing power due to a high inflation which stubbornly remains above target due to high rice prices.

The Bank of Japan should continue hiking rates gradually to approach 1.5% in 2027 in order to guide inflation closer to its 2% target. Over 2025, Japanese long-term bond yields have moved decisively higher, the 10-year JGB yield now exceeding 2%. These higher yields risk i) triggering the unwinding of yen carry trades and ii) a gradual repatriation of capital to Japan.

We see modest potential appreciation of the yen this year (to Y148 v USD in 12 months), with the interest rate differential between the Fed cutting rates and the BoJ increasing rates supporting the Japanese currency. The government has decided to apply more fiscal stimulus, which may limit yen strength, but which should support Japanese stocks.