TOKYO: Japan's switch to aggressive reflationary policies got off to a good start, but long-term investors remain wary of the Nikkei share market's acute volatility and are hesitant to commit as a debate within the government over hiking the sales tax heats up.
The Nikkei's gain since the start of the year was trimmed to under 30%, from 50% in May, and investors such as pension funds have yet to be convinced whether they should buy into Prime Minister Shinzo Abe's strategy for breaking Japan's long cycle of deflation.
"These investors have long turned their back on Japan because of many years of poor performance," said Yoshito Sakakibara, economist at JPMorgan Asset Management. "Buying by these players is necessary for Japanese markets to become more
Without sustained increases in the stock market and a decline in the yen, the effects of the Bank of Japan's easy policies are unlikely to spread through the economy. But the Nikkei's erratic moves over the past three months has made investors cautious.
Since a 7.3% plunge on May 23, the Nikkei has had 35 sessions where intra-day swings exceeded 2.5%. Prior to that, those levels of volatility were seen on just 16 days since the start of the year. In 2012, there were only four such days.
"Recent high volatility is likely to make long-term investors hesitant about investing in Japanese share markets," Sakakibara said.
By contrast, the S&P 500 has had just two such days in 2013, and the Euro STOXX 50 has had 16.
The Nikkei's swings can be partly attributed to rising popularity of leveraged exchange-traded funds. These funds need to place orders at the market close to track the index's direction, which amplifies moves in the final hour of trade.
Trading in Nikkei futures at the Chicago Mercantile Exchange also suggests that short-term speculators are taking a more active market role.
"Fast money had never controlled the Tokyo market like this before," said Kyoya Okazawa, head of global equities and commodity derivatives at BNP Paribas in Tokyo.
IMPLICATIONS FOR YEN
The Federal Reserve's hints that it was preparing to taper its asset-buying stimulus were the catalyst for the Nikkei's fall from its 5-1/2 year high in May, and markets around the world will be riveted to the Fed's actions over the coming months.
But within Japan, investors will also be watching whether the government decides to go through with a planned increase in the sales tax, after it holds hearings with economists and business leaders.
The sales tax is set to rise to 8% from 5% next April, and to 10 percent in October 2015. The government must make a final decision on whether to carry out this plan, modify it, or cushion it with extra government spending.
Government data on Friday showed rising prices, falling unemployment, higher incomes and factory activity gathering momentum, which pointed to an ongoing recovery in the world's third-largest economy.
Finance Minister Taro Aso said after the data that economic trends were favourable for the chances of raising the sales tax as planned next April.
But Aso also warned that Japan's share and bond markets could plunge if the government failed to implement the proposed tax increase as investors would doubt its resolve to bring down the country's public debt, which is the highest of all industrialised economies as a percentage of gross domestic product.
Advocates of the sales tax increase are concerned about the perception overseas should Abe get cold feet, said Bart Wakabayashi, head of forex at State Street Global Markets in Tokyo.
"They feel that if they don't raise the tax, the negative influence will show itself in the form of foreign money pulling out of Japan," he said.
That could have implications for the dollar-yen exchange rate. Money leaving Japanese assets does not necessarily lead to a weaker yen, as the currency remains a perennial safe-haven play.
The dollar was buying 98.12 yen on Friday, still up around 13% against its Japanese counterpart for this year. But it is well below its 4-1/2 year high of 103.74 yen hit in
May, and many investors take their directional cues from the stock market's volatile intraday swings.
"Dollar-yen tends to track the Nikkei," Wakabayashi said. "Following the Nikkei is easy trading for some people." – Reuters