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Naoya Nishimura

Naoya Nishimura

Executive Director, MSCI Research

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A New Era for the Bank of Japan?

  • As Haruhiko Kuroda steps down as governor of the Bank of Japan (BOJ) after a decade, the soon-to-be-appointed new governor, Kazuo Ueda, is expected to review the BOJ’s ultra-easy monetary policy in a new light.
  • We outline three scenarios around the BOJ’s monetary policy and assess their potential impact on investment portfolios.
  • In the case of “gradual policy normalization,” our model portfolio could gain 0.3%. Under the “full-scale tightening” and “dovish policy” scenarios, the same portfolio may experience a 6% or 3% loss, respectively.

As Haruhiko Kuroda steps down after a decade as governor of the Bank of Japan (BOJ), the central bank gets a new governor on April 9. The soon-to-be-appointed Kazuo Ueda, an economics professor and former member of the BOJ policy board, is expected to review the BOJ’s ultra-easy monetary policy. This “outsider” to Kuroda’s reign has the potential to shake things up, but what could that mean for Japanese institutional investors? Under our baseline “gradual policy normalization” scenario, a portfolio of global equities and U.S. and Japanese government bonds could gain 0.3%. In our less favorable scenarios, “full-scale tightening” and “dovish policy,” however, the same portfolio may experience a 6% or 3% loss, respectively.


Japanese monetary policy and potential scenarios

While monetary policy1 is not the only factor affecting a country’s inflation, Japan’s inflation rate had been mostly in positive territory since Kuroda took office in 2013 — until the pandemic brought it to negative in 2020. Inflation accelerated in 2022 due to the rise in import prices, but the BOJ’s latest outlook estimated that inflation will slow to below 2% in 2023, as factors that pushed up import prices, such as high energy prices and a weaker Japanese yen, are expected to wane.


Japanese inflation spiked in 2022

This exhibit shows more than two decades of data from Japan’s consumer price index. It shows how Japanese inflation spiked to some of its highest levels of the last 20 years in 2022.

Source: Portal Site of Official Statistics of Japan (e-Stat), MSCI

While the data suggests the period of persistent deflation seems to have passed, the side effects of the monetary policy have been the subject of a lingering debate, from liquidity issues in ETF markets to distortion of the price-discovery function of bond markets. The BOJ recognized that the functioning of bond markets had “deteriorated” and relaxed its policy of yield-curve control in December.2

Ueda has said that the current ultra-easy monetary policy needs to be reviewed at some point, but also stressed that easy monetary policy “is appropriate” and “must carry on,” considering the state of the economy.3 With this background, we outline three scenarios for the Japanese economy and the BOJ’s monetary policy, with the baseline scenario reflecting Ueda’s balanced view and assuming he pursues gradual policy normalization while keeping monetary policy accommodative:4

  • Gradual policy normalization: U.S. rates remain high, while the economy grows slowly. No further global downside risks materialize. The BOJ seeks policy normalization, but at a very gradual pace to keep monetary policy accommodative. Both U.S. and Japanese stock prices rise on the economic recovery. JPY appreciates vs. USD as the Federal Reserve eventually pauses its rate hikes, while the BOJ seeks normalization.
  • Full-scale tightening: Central banks fail to tame inflation and need to hike rates further. Global inflation infiltrates Japan through import prices, and persistent inflationary pressure raises Japanese consumers’ inflation expectations. Considering accelerating Japanese inflation, the BOJ is forced to implement full-scale tightening. Both stock and bond prices fall. JPY depreciates vs. USD.
  • Dovish policy: As a result of the fight against inflation, the U.S. economy goes into recession, and the Federal Reserve cuts rates. The BOJ stops pursuing policy normalization, faced by the worsening economic environment and expands its asset-purchasing program. Both U.S. and Japanese stock prices fall due to the recession. JPY appreciates vs. USD as U.S. nominal rates fall more than Japanese nominal rates.


Our scenario assumptions

The exhibit is a table detailing the various assumptions that went into the three scenarios in the analysis. For the “full-scale tightening” scenario, we assume Japanese two-year breakeven inflation will rise by 50 basis points, nominal yields on two-year Japanese government bonds will rise by 75 basis points and Japanese equities will drop by 15%.

Scenario assumptions are informed by the MSCI Macro-Finance Model, analysis of historical data and judgment. These are not forecasts, but hypothetical narratives of how the macroeconomic scenarios could affect multi-asset-class portfolios. Breakeven inflation (BEI) is measured in basis points (bps).


Potential implications for Japanese investors’ portfolios

To assess the scenarios’ impacts on multi-asset-class portfolios from Japanese investors’ point of view, we used MSCI’s predictive stress-testing framework and applied it to a hypothetical composite portfolio consisting of global equities (Japan and global equities ex-Japan) and U.S. and Japanese government bonds. The chart below shows details of the impact by asset class in JPY terms.


Impact across asset classes under our scenarios in JPY

This exhibit is a bar chart that shows the impact of the three scenarios on various portfolios. It shows, among other things, that Japanese equities could drop by more than 5%, while Treasurys could fall by more than 4%, in the “gradual policy normalization” scenario.

Portfolio impact of the scenarios based on market data as of Jan. 31, 2023. Note that the stress test results capture the effect of repricing of the assets, not the income component. Japanese equity is represented by the MSCI Japan Index, global equity by the MSCI ACWI ex Japan Index, U.S. Treasurys by the MSCI USD Government Bond Index and Japanese government bonds by a market-cap-weighted custom Japanese-government-bond portfolio. The composite portfolio is an equal-weighted mix of Japanese equities, global equities, U.S. Treasurys and Japanese government bonds.

While the BOJ’s future policy direction is an important factor for Japanese stocks and bonds, the return of a composite portfolio, which is diversified across Japanese and non-Japanese assets, was impacted by external factors as well. Under our “gradual policy normalization” and “dovish policy” scenarios, Treasury prices rose in USD terms; but in JPY terms, the gain was offset by the depreciation of the USD against the JPY. On the other hand, the depreciation of the JPY under the “full-scale tightening” scenario partly offset the losses from the global-stock and -bond bear markets.5

Our result suggests the asset-class returns could vary significantly depending on the scenario. Faced with this uncertainty, investors may wish to evaluate a range of potential scenarios and consider appropriate strategies.



1To achieve the 2% inflation target, the BOJ is currently implementing “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control (YCC).” Under this policy, the BOJ is controlling the policy rate and 10-year government-bond yield. They are also purchasing equity and REIT ETFs.

2“Statement on Monetary Policy.” Bank of Japan, Dec. 20, 2022.

3“Factbox: Kazuo Ueda: Who is the new Bank of Japan governor and what can we expect from him?” Reuters, Feb. 10, 2023.

4For the global economy, we incorporate scenarios from our recent blog post to determine external factors that may affect the BOJ’s decision. The “gradual policy normalization,” “full-scale tightening” and “dovish policy” correspond to the “baseline,” “mild stagflation” and “hard landing” scenarios, respectively.

5The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can access BarraOne® and RiskMetrics® RiskManager® files for these scenarios on the client-support site.



Further Reading

Four Scenarios for 2023: Navigating Uncertainty

Looking Beyond Japan to Understand Risks to the Yen

Global Markets One Year After Russia’s Invasion of Ukraine

Pagination Portlet