Welcome to Japan’s new inflationary era:
Why the weaker yen could keep driving equity gains

Highlights:

• Japan’s real exchange rate remains exceptionally weak, suggesting inflation is likely to persist and the yen is unlikely to strengthen materially over the medium term.
• The recent Nikkei correction was largely driven by profit-taking in AI and semiconductor-related stocks rather than a deterioration in Japan’s broader market outlook.
• Despite Japan’s current account surplus, much of the surplus comes from overseas investment income that is reinvested abroad, limiting support for the yen. Meanwhile, trade and services balances remain under pressure.
• Structural factors, including overseas investment by Japanese households and companies, suggest continued medium-term yen weakness.
• While coordinated currency intervention can temporarily strengthen the yen, it is unlikely to reverse underlying trends without a meaningful change in economic fundamentals.
• A sharp correction in US equities could trigger temporary yen appreciation through capital repatriation, but it would likely coincide with broader global equity weakness. 
• Japanese equities remain attractive as a hedge against rising domestic inflation. If the yen’s real undervaluation is corrected through higher Japanese inflation rather than nominal currency appreciation, corporate earnings and equity valuations could benefit.
• Japanese stocks may also continue outperforming in US dollar terms. Many Japanese companies generate a growing share of revenues and profits overseas, making them beneficiaries of yen depreciation through the increasing yen value of foreign assets and earnings.