Japan's Stock Market Echoes Late 2023 'Fed Pivot Rally' Conditions

Japan's stock market is entering a phase reminiscent of late 2023, where a sharp rise in U.S. long-term Treasury yields was followed by a 'Fed pivot rally'. This time around, however, Bank of America warns that stronger fundamentals will be needed to sustain gains.

The U.S. Treasury has decided to double the cap on its buybacks of longer-dated government bonds, which could ease investor concerns over the recent rise in long-term yields. The Treasury will raise the buyback cap for securities maturing in 10-20 years and 20-30 years to at least $4 billion per operation from $2 billion between Sept. 9 and Nov. 4.

Bank of America notes that this move echoes conditions seen in November and December 2023, when U.S. long-term yields fell sharply as economic data weakened, inflation slowed, and markets began pricing an end to Federal Reserve rate hikes. Japanese equities rose toward year-end despite a significant appreciation in the yen.

However, BofA cautions that the current backdrop differs from 2023, citing a weak yen, Middle East turmoil, and a manufacturing recovery that could drive both higher Japanese corporate earnings and higher interest rates. Expectations that the Bank of Japan will accelerate rate hikes also mean it may be premature to assume the rise in rates has run its course.

BofA expects the market to gradually shift away from momentum- and beta-driven performance toward greater stock selection, with a focus on artificial-intelligence-related shares, IT services, gaming, and intellectual-property companies that lagged the AI rally but have reported strong first-quarter results. Domestic-demand stocks could also benefit if the yen stabilizes.