The Nikkei 225 briefly topped 60,000 on April 23. The turmoil in Iran continues, and if nothing changes, Japan faces the unprecedented risk of an accelerating decline in production due to shortages of crude oil and naphtha along with related restrictions. It seems puzzling that stock prices are moving steadily higher under such circumstances. I suspect the Nikkei 225 is no longer a mirror that reflects the Japanese economy and is failing to capture current economic conditions and the broader corporate earnings and business environment.
There are three conceivable reasons for the rise in Japanese stock prices despite the ongoing turmoil in Iran. The first is the influence of bullish US equity markets. The magnitude of the economic risk posed by a closure of the Strait of Hormuz is very different for Japan and the US. Japan relies on imports passing through the Strait for roughly 90% of its crude oil. A continued blockade would create a serious risk of crude oil and naphtha shortages. Although the government is working to secure alternative supply routes, routes going through the Red Sea could also be cut off abruptly if the conflict expands to that region. And for Japan, which imports nearly all of its crude oil, the rise in crude oil prices due to the blockade leads to outflows of income through a deterioration in its terms of trade.
In contrast, the direct impact of a blockade on the US economy is limited because only a small portion of US crude oil imports pass through the Strait. The US is the world’s largest crude oil producer and is a net exporter. Higher crude oil prices therefore improve its terms of trade and boost US income.
Given the strong linkages between financial markets in Japan and the US, Japanese stock prices—which should be adversely affected by rising crude oil prices—are being pushed unexpectedly higher by stock market gains in the US, which benefits from higher oil prices. Despite the ongoing conflict in Iran, market expectations for the AI boom in the US have not diminished and continue to boost the stock prices of related Japanese companies.
The second reason, which is related to the first, is the impact of a stronger dollar and weaker yen. Rising crude oil prices improve the trade balance of the US, a net exporter of crude oil, and generate greater income, which leads to dollar buying.
The resulting dollar strength and yen weakness has traditionally tended to bolster Japanese stock prices. This is because investors expect a weaker yen will increase export revenues in yen terms and boost the earnings of exporters.
Although rising crude oil prices depress corporate earnings, there is a growing perception in financial markets that leading Japanese companies now have the ability to sustain their earnings by passing on higher costs to customers. Because small and micro enterprises generally find it difficult to pass on higher costs caused by rising oil prices and a weaker yen, their earnings tend to be squeezed. But the Nikkei 225 is composed of large corporations and does not reflect the earnings of these smaller businesses.
A third contributing factor is the Bank of Japan's decision to leave rates on hold. Market expectations for a rate hike at the April 28 Monetary Policy Meeting, once seen as almost certain, have rapidly diminished in response to the Iran situation. I suspect this is one of the factors behind the recent rise in stock prices.
At a fundamental level, the BOJ's sustained monetary easing has also contributed to the upswing in stock prices over the past several years. Keeping real interest rates low lifts the prices of real estate, stocks, and other assets. Monetary accommodation also depresses the value of the yen, creating a cycle of yen weakness and rising prices.
A weaker yen and higher prices have squeezed household living standards via lower real wages and a shrinking labor share, but it is precisely these distortions that have boosted nominal earnings for large enterprises and fueled the upward trend in stock prices.
In short, the recent gains in the Japanese stock market do not reflect the economy, people's livelihoods, or the broader corporate earnings and business environment. It might be better described as demonstrating an economic distortion of sorts.
A collapse of this stock market rally amid the ongoing turmoil in Iran would not necessarily signal weakness in the Japanese economy. The risk is more likely to lie in the US economy. While higher crude oil prices could serve as a tailwind for the US—which is after all a net oil producer—in the short term they would tend to weigh on personal consumption via higher prices for gasoline and other fuels, just as in oil importing countries like Japan. In the US, where the Trump tariffs and other factors have already brought about signs of a change in labor market conditions, a sharp rise in gasoline prices could cause personal consumption to stall.
Private credit—lending to non-listed companies—is another lingering concern in the US. If problems in this sector spread, constraints on funding for these companies could weigh on the US economy and potentially lead to problems in the banking system.
There are three conceivable reasons for the rise in Japanese stock prices despite the ongoing turmoil in Iran. The first is the influence of bullish US equity markets. The magnitude of the economic risk posed by a closure of the Strait of Hormuz is very different for Japan and the US. Japan relies on imports passing through the Strait for roughly 90% of its crude oil. A continued blockade would create a serious risk of crude oil and naphtha shortages. Although the government is working to secure alternative supply routes, routes going through the Red Sea could also be cut off abruptly if the conflict expands to that region. And for Japan, which imports nearly all of its crude oil, the rise in crude oil prices due to the blockade leads to outflows of income through a deterioration in its terms of trade.
In contrast, the direct impact of a blockade on the US economy is limited because only a small portion of US crude oil imports pass through the Strait. The US is the world’s largest crude oil producer and is a net exporter. Higher crude oil prices therefore improve its terms of trade and boost US income.
Given the strong linkages between financial markets in Japan and the US, Japanese stock prices—which should be adversely affected by rising crude oil prices—are being pushed unexpectedly higher by stock market gains in the US, which benefits from higher oil prices. Despite the ongoing conflict in Iran, market expectations for the AI boom in the US have not diminished and continue to boost the stock prices of related Japanese companies.
The second reason, which is related to the first, is the impact of a stronger dollar and weaker yen. Rising crude oil prices improve the trade balance of the US, a net exporter of crude oil, and generate greater income, which leads to dollar buying.
The resulting dollar strength and yen weakness has traditionally tended to bolster Japanese stock prices. This is because investors expect a weaker yen will increase export revenues in yen terms and boost the earnings of exporters.
Although rising crude oil prices depress corporate earnings, there is a growing perception in financial markets that leading Japanese companies now have the ability to sustain their earnings by passing on higher costs to customers. Because small and micro enterprises generally find it difficult to pass on higher costs caused by rising oil prices and a weaker yen, their earnings tend to be squeezed. But the Nikkei 225 is composed of large corporations and does not reflect the earnings of these smaller businesses.
A third contributing factor is the Bank of Japan's decision to leave rates on hold. Market expectations for a rate hike at the April 28 Monetary Policy Meeting, once seen as almost certain, have rapidly diminished in response to the Iran situation. I suspect this is one of the factors behind the recent rise in stock prices.
At a fundamental level, the BOJ's sustained monetary easing has also contributed to the upswing in stock prices over the past several years. Keeping real interest rates low lifts the prices of real estate, stocks, and other assets. Monetary accommodation also depresses the value of the yen, creating a cycle of yen weakness and rising prices.
A weaker yen and higher prices have squeezed household living standards via lower real wages and a shrinking labor share, but it is precisely these distortions that have boosted nominal earnings for large enterprises and fueled the upward trend in stock prices.
In short, the recent gains in the Japanese stock market do not reflect the economy, people's livelihoods, or the broader corporate earnings and business environment. It might be better described as demonstrating an economic distortion of sorts.
A collapse of this stock market rally amid the ongoing turmoil in Iran would not necessarily signal weakness in the Japanese economy. The risk is more likely to lie in the US economy. While higher crude oil prices could serve as a tailwind for the US—which is after all a net oil producer—in the short term they would tend to weigh on personal consumption via higher prices for gasoline and other fuels, just as in oil importing countries like Japan. In the US, where the Trump tariffs and other factors have already brought about signs of a change in labor market conditions, a sharp rise in gasoline prices could cause personal consumption to stall.
Private credit—lending to non-listed companies—is another lingering concern in the US. If problems in this sector spread, constraints on funding for these companies could weigh on the US economy and potentially lead to problems in the banking system.
Profile
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Takahide KiuchiPortraits of Takahide Kiuchi
Executive Economist
Takahide Kiuchi started his career as an economist in 1987, as he joined Nomura Research Institute. His first assignment was research and forecast of Japanese economy. In 1990, he joined Nomura Research Institute Deutschland as an economist of German and European economy. In 1996, he started covering US economy in New York Office. He transferred to Nomura Securities in 2004, and four years later, he was assigned to Head of Economic Research Department and Chief Economist in 2007. He was in charge of Japanese Economy in Global Research Team. In 2012, He was nominated by Cabinet and approved by Diet as Member of the Policy Board, the committee of the highest decision making in Bank of Japan. He implemented decisions on the Bank’s important policies and operations including monetary policy for five years.
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