The year 2024 is nearing its end, and a noticeable disparity has emerged in the global marketsThe robustness of the U.Sdollar and the performance of the U.Sstock market have overshadowed other significant markets globallyDespite central banks adopting disparate monetary policies, the market's momentum seems anchored by anticipated economic and policy trendsThis scenario is vividly illustrated by the contrasting actions of the Federal Reserve and the Bank of Japan (BoJ). While the Fed has slashed interest rates three times this year, lowering the federal funds target rate by a cumulative 100 basis points to a range of 4.25% to 4.5%, the BoJ marked a historic shift by raising rates twice, pushing the current rate to 0.25%.

The implications of these policy decisions reveal deeper economic narrativesAs we previously highlighted, the different trajectories of these two central banks have not diminished the appeal of U.S

economic resilience and elevated interest rates, thereby continuing to exert pressure on Japanese assetsRemarkably, following the Fed's interest rate cuts, Japanese investors have seen the yield on currency-hedged U.Sgovernment bonds surpass zero for the first time in over two yearsAs of October, the 10-year U.STreasury yield hedged for yen stood at 0.28%, a significant rise from the sub-zero levels maintained since September 2022. This shift underscores the increasing attractiveness of U.Sbonds amidst policy loosening in the U.Sand rising borrowing costs in Japan, resulting in a decline of approximately 170 basis points from the peak hedging costs recorded in October 2023.

This trend of Japanese capital flowing into the U.Sbond market likely has a long runway ahead, with expectations extending into 2025. Following policy gatherings by the U.Sand Japanese central banks, traders have grown skeptical about the pace at which the interest rate gap between the two economies is narrowing, thereby curtailing bets on a strengthening yen.

In a revealing statistic, the latest data from Japan's Finance Ministry indicates that net purchases of U.S

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bonds by Japan reached a whopping 15.1 trillion yen (approximately 9.6 billion USD) during the first ten months of this yearThis figure, however, falls short of last year’s record net purchases of 20 trillion yen from January to OctoberIn contrast, this year’s January to October period has seen the yen depreciate against the dollar by about 7%. As U.Syields remained above 4%, capitalizing on buying opportunities presented by a lower yen seems a prudent strategy for investors aiming to benefit from both debt capital gains and currency returns.

While the Japanese stock market has not garnered momentum comparable to its American counterpart, the Topix Index has still managed to set several historical highs in 2024, climbing approximately 15% overallHowever, this increase has diminished significantly for investors counting in dollarsData from Bloomberg illustrates that the dollar-denominated ascent amounts to merely 3% due to the yen's depreciation against the dollar, which has dropped roughly 10%. This increase pales in comparison to the performance of global rivals, such as the S&P 500, which has surged over 25% in dollar terms.

Despite the yen's depreciation, which has bolstered exporter profits, and the positive effects of the BoJ's interest hikes on financial stocks, the limited inflow of capital this year suggests that the yen's fragility and volatility are deterring foreign investment

The depreciation of the yen also exerts inflationary pressures and elevates import costs on the domestic economyGoldman Sachs posits that the current exchange rate of the yen against the dollar favors foreign investors seeking to purchase Japanese stocksHowever, the risk remains limited that the yen will fall below 160 to the dollar, especially given potential interventions from Japanese authorities.

This situation arguably presents an opportune moment for foreign funds to acquire Japanese equities at comparatively lower prices, especially since the potential for a decline in the yen's value due to its depreciation against the dollar arisesShould the yen gain strength, overseas funds could also uncover opportunities to profit from currency fluctuationsAnalysts anticipate that, in the context of stock repurchases, cross-shareholdings being unwound, and the central bank's interest rate increases, banks and other financial entities are poised to perform well in 2025.

Since a dramatic plunge in August, the Japanese equity market has recaptured a considerable amount of its losses