BoJ on hold; US-Japan trade talk sending a cooperative tone; staying neutral on JPY and Japan equities, underweight on JGBs

Highlights: The Bank of Japan (BoJ) kept policy rate steady at 0.50 per cent in its October meeting. While the BoJ did not offer too much new hints on a rate hike timeline, we think it remains a matter of when, and not whether, the central bank will hike. We now expect the BoJ to have a 25bp hike in the December meeting. US President Trump and Japan Prime Minister Takaichi met on 28 October with a cooperative tone, in-line with our view that the global trade uncertainties should de-escalate and investors should focus more on market fundamentals. We stay neutral on JPY and Japanese equities and underweight on JGBs in our global asset allocation.

• Why we think there will be a rate hike in December: The BoJ reiterated its long-standing narrative in the October meeting that it will raise benchmark rate if economic growth and inflation perform in-line with its expectations. Latest domestic price and wage trends are supportive. In addition, the US Fed’s guidance that a December Fed rate cut is far from certain may lead to the US-Japan interest rate differential to widen again in the near-term, weighing on JPY. This could increase the pressure on the BoJ to tighten policy at its December meeting to reduce the risk of excessive JPY depreciation
• JPY (Neutral): The JPY has weakened the most among major currencies this month against the USD as Takaichi emerged as Japan’s new Prime Minister after winning the LDP leadership vote. Market concerns about fiscal sustainability could stay elevated if Japan’s fiscal policy become substantially more expansionary. This would add to near-term volatility for the JPY
• JGBs (Underweight): We expect near-term volatility of JGBs, especially in longer end of the curve, as markets may be concerned about higher issuance of government debt and fiscal sustainability risks under Takaichi’s expansionary policy agenda
• Japanese equities (Neutral): While Japanese equity market performance has been strong of late, boosted by upward revisions to consensus earnings estimates, Takaichi’s election, a soft JPY, and corporate reforms, we think the valuation of the Japan stock market is fair at 16.0x forward P/E. We favour domestic reflation plays in Japanese technology, financials, and consumer stocks, but cautious on exporters due to negative impact of US tariffs