Today, Japan’s Topix hit a new all-time high, finally breaking the previous record dating back to 1989. Since about March 2020, the Topix has risen about 125% on a total return basis (i.e. including reinvested dividends). This is only a few percentage points lower than the S&P 500, while the Euro Stoxx 50 has risen about 100% and far exceeds the FTSE 100’s 68%.

There is just one small problem. These are in local currency. If you convert all the results to sterling, the gains in the eurozone and the US are surprisingly similar, but the Topix's total gain is less than 50%, less than the UK market's gain over the same period.

It is the weaker yen that has caused this difference. The yen has depreciated significantly during this period because, despite several minor adjustments, Japan's ultra-loose monetary policy has been maintained for much longer than expected. As a result of the Bank of Japan's disregard, funds have gone offshore in search of other higher-yielding investment opportunities.

A few days ago, Louis-Vincent Gave, co-founder of financial services company Gavekal Research, pointed out in an article that funds from Japan are seeking better investment destinations, and these funds are an important factor in Japan's keeping interest rates at a low level globally. He also believes that overseas investment in US dollars not only flows into US Treasuries, but also pours into semiconductor stocks such as Nvidia, thereby pushing up the bubble there.

Assuming that is the case, what might change that? Udith Sikand of Gavekal Research notes that rekindling inflation is starting to become a political issue in Japan. Japanese authorities may have wanted to revive inflation for decades, but Japanese consumers, like consumers anywhere in the world, don’t like rising inflation, and now they are becoming increasingly unhappy.

According to Sikand, surveys show inflation is the main driver of Prime Minister Fumio Kishida's low approval ratings. This in turn makes the weak yen a political issue because it is a key factor driving higher inflation for an economy like Japan that relies on imported energy.

If the Japanese government and people believe that controlling inflation is critical, you can bet that the central bank will start paying attention to this issue. But how does Japan, a highly indebted country even by today's standards, respond to rising bond yields? This is where financial repression comes into play.

As Sikand puts it: “By ‘guiding’ Japanese institutions to repatriate capital from overseas, or by adjusting the rules of tax-free savings schemes to discourage overseas investment, they can kill two birds with one stone – reverse the capital outflows that have weakened the yen, while stimulating domestic demand for JGBs, thereby capping JGB yields.”

Usually, the timing and financial operations involved are very complicated. But in simple terms, if the funds of Japanese overseas investors are reversed, the prices of assets that benefit from these flows will fall (if these assets are government bonds, it will push up the government bond yields), while the assets that benefit from the return of funds will rise. If there are large fluctuations involved, it may also push up market volatility.

Analyst John Stepek believes this is a concern because the potential turmoil caused by a rapid reversal of capital flows could be greater than the events since Macron and Le Pen, or Biden and Trump.

The article is forwarded from: Jinshi Data