Japan implemented negative interest rates in January 2016, surprising global markets with an unconventional monetary policy to combat deflation and stimulate economic growth.
The policy, implemented after other monetary moves failed to have the desired effects, has sought to encourage banks to lend, consumers to spend and businesses to invest by penalizing holding excessive reserves.
Eight years later, this monetary experiment could be coming to an end – as soon as this month. Reuters has reported that a “growing number” of Bank of Japan policymakers are leaning in that direction amid expectations of hefty pay hikes in this year’s annual wage negotiations.
If Reuters and others predicting a policy shift have it right, then what can be expected after negative rates are made positive?
Such a shift is likely to lead initially to a stronger yen, a reflection in part of growing optimism in the domestic economy. However, sustained yen strength would also pose serious challenges for Japanese exporters who have benefitted from a recent weakening of the currency.
Japanese stocks can be expected to experience volatility as investors adjust their portfolios in response to the policy change. Industries sensitive to interest rates, such as financials, can be expected to see significant movements.
Japanese government bonds (JGBs) are a significant component of global bond markets. Any shift in Japan’s interest rate policy will cause investors to reassess their portfolio positions, affecting bond markets globally.
Global equity markets could also see volatility. Sectors with significant exposure to Japan, including automotive and consumer electronics, can be expected to see price fluctuations based on currency movements and the underlying performance of major Japanese companies.
The performance of major Japanese corporations like Toyota, Honda, Sony and Panasonic greatly influences investor sentiment towards these broad sectors.
Positive earnings reports or strategic shifts by these companies can buoy stock prices across their respective sectors globally while setbacks or underperformance can stoke downward pressure.
How a potential shift from negative to positive interest rates impacts these Japanese giants will be key to investor sentiment.
Another key impact is that Japanese investors are likely to reconsider their global portfolios if domestic assets become more attractive due to higher interest rates.
This would likely lead to capital outflows from foreign markets that potentially impact asset prices, particularly in regions and sectors that were previously favored by Japanese investors.
Media reports indicate there is no consensus within the BOJ’s nine-member board on whether to scrap the negative rate policy at its upcoming March 18-19 meeting.
But investors worldwide will be keenly watching for a policy change or hints of a future shift that if implemented will impact the trajectory of markets in the months and years ahead.