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    Nikkei Index Suffers Three-Day Decline Amid Rate Hike Concerns

    The Nikkei, which made a record high above 40,000 last week, posted its sharpest fall in five months on Monday.

    Japan’s Nikkei share average fell for a third straight session on Wednesday as investors assessed the likelihood of a policy shift at next week’s Bank of Japan (BOJ) meeting.

    The Nikkei fell 0.26% to close at 38,695.97, retreating after briefly surpassing the psychologically significant 39,000 level.

    The broader Topix ended 0.33% lower at 2,648.51.

    Market players were trading with caution ahead of the BOJ’s policy meeting, with many expecting Japan’s central bank to lift short-term interest rates from negative territory either next week or by April.

    Chip-related shares tracked overnight Wall Street gains to cap the losses, with Tokyo Electron and Advantest rising 2.41% and 0.36%, respectively.

    However, 137 of the index’s 225 constituents declined, with losses in major shares such as SoftBank Group, down 0.19%, and Uniqlo-brand clothing shop operator Fast Retailing losing 0.69%.
    Electrical equipment manufacturer Daikin Industries fell 2.64%.

    The yen strengthened in the Asian morning, weighing on exporters that benefit from a weaker currency, as traders awaited the initial results of the closely watched spring wage negotiations, due out on Friday.
    Toyota Motors was down 0.89%.

    “If a higher rate of wage increases than last year is confirmed, views that the BOJ will exit from negative interest rates at the March meeting will strengthen,” said Maki Sawada, a strategist at the investment content department of Nomura Securities.

    In that case, “the appreciation of the yen against other currencies will likely weigh on stock prices,” she added.

    SWEET SPOT

    Previous hiking cycles in Japan took place under such different circumstances that comparisons are tricky.

    In 1989-90 it raised rates by more than 300 basis points, bursting a property bubble and crushing the economy and stock market for a decade. In 2006, an attempt to end a zero-rate policy fell flat as inflation couldn’t be sustained.

    This time investors and policymakers both point to higher wages and changes in companies’ attitudes as new elements. Pay negotiation data due on Friday, before the BOJ meets, can move markets especially if it surprises to the upside.

    “Markets still underprice any long-term changes in Japan,” said Ales Koutny, head of international rates at Vanguard, who is increasing short exposure to Japanese government bonds.
    “A wage number high enough that supports consumption could focus minds on a potential longer hiking cycle.”

    He sees the five- to 10-year tenors as most vulnerable if the BOJ winds back its support and says 10-year yields could surpass 1% and in the longer term trade like German bunds – which yield 2.3% – if wages, consumption and inflation start to reinforce one another.

    Two-year Japanese yields, which track short-term rate expectations, have hit 13-year highs at 0.2%, five-year yields and 10-year yields are around multi-month highs of 0.4% and 0.77%, respectively.

    The yen, after hitting levels near its cheapest on record in real terms, last week climbed 2% for its sharpest weekly jump on the dollar in eight months as short-sellers retreated slightly.

    To be sure the journey out of such a long period of unorthodox policy is fraught and the distortions wrought on the economy will take a long time to unwind. Smaller businesses in particular face challenges from higher borrowing costs.

    Crowded bets on bank stocks are vulnerable to “sell the fact” losses on a policy shift, says Nomura’s Japan macro strategist Naka Matsuzawa. Already, the BOJ’s refusal to buy equity funds when markets fell this week has unnerved some investors.

    A yen rally to 135 or 130 to the dollar could also trigger worldwide reverberations, investors say, as that would likely trigger “carry” trades funded in yen to be unwound.

    Yet, at 147 to the dollar on Wednesday that is a long way away and most see a tentative return of animal spirits to Japan as a positive.

    “In 2024, Japan has neither an overheating property market nor is it mired in deflation,” said Byron Gill, managing partner at Indus Capital Partners in San Francisco, with real rates – the nominal rate less inflation – likely to stay sub zero.

    “If, at the same time, wage growth can overtake the rate of inflation,” he said. “Japan may find itself in a real sweet spot for both the economy and for risk assets.”

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