Nikkei Climbs Back to 40,000, Reaching Yearly High, While Japanese Bonds Plummet

TradingKey - On Tuesday, Eastern Time, President Trump announced a trade agreement with Japan, reducing tariffs on Japanese imports to 15%. Meanwhile, rumors of Japanese Prime Minister Shigeru Ishiba's planned resignation emerged, causing Japanese stocks to soar sharply, while bonds plunged.

By Wednesday in Tokyo, both the Topix and Nikkei indices hit new annual highs, each climbing over 3%, with the Nikkei reclaiming the significant 40,000 level. Automotive stocks were particularly outstanding, with Mazda rising 17.77%, Toyota gaining 14.34%, and Honda up by 11.15%.

At the same time, Japanese bonds fell across maturities from one year to forty years, leading to a sharp rise in yields. The benchmark 10-year government bond yield rose by as much as 9.5 basis points to 1.595%, nearing its highest level since 2008. 

Analysts suggest that the decline in shorter-term bonds, which are more sensitive to monetary policy, reflects increased market expectations for a rate hike by the Bank of Japan this year. The drop in long-term bonds is attributed to concerns over growing government fiscal expenditure.

Optimism Drives Japanese Stocks Higher with Lower Than Expected Tariffs and Prime Minister’s Planned Resignation

According to a post by Trump on Truth Social, the United States will impose a 15% reciprocal tariff on Japan. Additionally, sources indicate that the U.S. will levy a 12.5% tariff on Japanese car imports, halving the previous rate of 25%, resulting in a total of 15% when combined with a 2.5% basic tariff rate.

Andrew Jackson, a Japan equity strategist at Ortus Advisors, noted that many investors previously anticipated tariffs of at least 20%. Rajeev de Mello, portfolio manager at GAMA Asset Management, added that the 15% tariff level, lower than the prior 25%, is favorable for market sentiment.

This news benefits Japanese companies broadly, leading to widespread gains in Japanese stocks, with automakers, a cornerstone of Japan's economy, emerging as the biggest winners. Mazda, which derives approximately 50% of its revenue from the North American market, saw the most notable increase.

Moreover, the rumor of Shigeru Ishiba's planned resignation also fueled market optimism. Previously, investors were concerned about the fiscal policies he might pursue if he remained in office. Gerard Cawley, a Japanese equity fund manager at London-based Polar Capital, remarked that the market prefers Ishiba's departure, allowing others to take over, thereby clarifying the market environment for investors.

Falling Uncertainty Boosts Rate Hike Expectations, Driving Japanese Bond Yields Higher

Citi analyst Tomohisa Fujiki suggests that the U.S.-Japan trade agreement reduces trade uncertainty, potentially paving the way for a rate hike by the BOJ.

Analysts at Capital Economics share a similar view, noting that this agreement removes a major downside risk for the Japanese economy and increases the likelihood of a BOJ rate hike by year-end.

Following the trade agreement, BOJ Deputy Governor Shinichi Uchida stated in a speech that there is no immediate need to raise the benchmark rate. However, overnight index swaps (OIS) show that investors believe the probability of a rate hike by year-end has surged from about 59% the previous day to 84% currently, indicating a significant increase in rate hike expectations.

Additionally, Japan's 40-year government bond auction held this Wednesday revealed a bid-to-cover ratio, which measures demand strength, dropping to 2.127, the weakest since 2011, highlighting market concerns over increasing government spending. This outcome also contributed to the rise in Japanese bond yields.