YOUR GOALS,OUR COMMITMENT.

Why households are key to the next phase ofJapan’s “virtuous circle” of reflation
Reflation seen incentivising household participation in financial markets
By Naomi Fink, Global Strategist
2 April 2024
On 19 March, the Bank of Japan (BOJ) joined the other developed economies by returning to traditional tools—shortterm interest rates—to govern monetary policy. However, the financial markets seem to understand that Japan’s
journey to structural reflation is far from over, and investors appear ready to make the most of ongoingaccommodation while it lasts. Policy rates of zero to 10 basis points (bps) and 10-year yields below 80 bps still makefor attractive funding conditions for investors to accumulate global assets—both of the “risk-free” sovereign variety
and many classes of risk assets thanks to ultra-low volatility. The structure of Japan’s current account shows why it isan opportune time to have a cash surplus in Japan and be able to increase one’s wealth by investing overseas (seeChart 1).

(JPY billion)

Chart 1: Major Components of Japan’s current account balance
35000
30000
25000
20000
15000
10000
5000
0
-5000
-10000Japan balance of Japan balance of Japan current
Japan current
Japan current
payments current payments trade account servies account primaryaccount
account balance,balance NSA
total net balance income balance secondary income
JPY bln NSA
balance
Source: Bloomberg, Nikko Asset Management Global Strategy. Data as at 28 March 2024.

To explore the mechanics of Japan’s enviable income earned on its investments overseas, we examine the returns
earned on two multi-asset portfolios, both invested in 60/40 “rule of thumb” allocations to the ACWI (the “risky” asset)
and a basket of 7- to 10-year US Treasuries (the “risk-free” asset), both on a yen-hedged (1-year rolling) and yen-fundedunhedged basis (Chart 2).

FOR SOPHISTICATED INVESTORS ONLY

WHY HOUSEHOLDS ARE KEY TO THE NEXT PHASE OF JAPAN’S “VIRTUOUS CIRCLE” OF
REFLATION

Chart 2: Stock/bond portfolio (60/40), unhedged (funded in yen) and hedged
20%
15%
10%
5%
0%
-5%
-10%
-15%

60/40 MSCI ACWI (1-year total return) and US 7-year-10-year bond return, annual
60/40 MSCI ACWI (1-year total return) and US 7-year-10-year bond return, annual (hedged)
Source: Bloomberg, Nikko Asset Management Global Strategy. Data as at 28 March 2024.

Even on a fully yen-hedged basis, the returns (above 7%) compare favourably to the annual yield targets of many
global institutional investors. Considering the combination of Japan’s relatively muted inflation (and thus, low rates)
and a surplus of built-up cash, the Japanese investor should be in the presence of near-ideal global investment
conditions. Yet when we look away from institutional investors and turn our focus to the balance sheet of households,
we observe that Japanese consumers are taking very little advantage of such conditions. Households have, over theyears, built up a formidable stock of cash on their balance sheet, most recently totalling around JPY1.1 quadrillion.
However, savings appear stubbornly mired. What is holding consumers back from taking advantage of the gains from
relative global yields?
As we have pointed out before, even though Japan’s corporates have been able to benefit from nominal growth toincrease their revenues, for Japanese households—as with consumers everywhere—real balances matter. What do
we mean by this? Firms have demonstrated their ability to absorb increased import costs, and they have passed themthrough to consumers. Meanwhile, the only way for consumers to offset price increases is by demanding higher
wages. This, all else being equal, increases costs for employers, who then rely on new increases in revenues (i.e., via
increased consumption) to maintain profitability. This is the “virtuous circle” that the BOJ has been looking for. But
despite nominal wage increases over the last few years, inflation has suppressed real income growth and kept it innegative territory (Chart 3).
Chart 3: Nominal versus real labour cash earnings
6
4
(%)

2
0
-2
-4
Jul-2023

Feb-2024

Dec-2022

Oct-2021

May-2022

Mar-2021

Aug-2020

Jan-2020

Jun-2019

Nov-2018

Apr-2018

Feb-2017

Sep-2017

Jul-2016

Dec-2015

May-2015

Oct-2014

Mar-2014

Aug-2013

Jan-2013

Jun-2012

Apr-2011

Nov-2011

Sep-2010

Feb-2010-6

Japan Labour Statistics average monthly cash earnings YoY
Japan Labour Statistics average monthly real cash earnings YoY
Source: Bloomberg, Nikko AM Global Strategy. Data as at 21 February 2024.

With the historic wage increases garnered by Japan’s labour unions in its “shunto” spring negotiations, there arecredible reasons to expect real income growth to turn positive in 2024. Nonetheless, sustained positive real income
growth has yet to be realised in the data, and this is one important development that the BOJ is likely waiting for
before it withdraws any further accommodation. Alongside such real income growth, the BOJ is likely to be looking
for consumer surpluses to be allocated not to building up cash deposits, such as was the case during Japan’s “lostdecades”, but to increasing their consumption. This would assist GDP growth and also put money to work in financial
markets.
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WHY HOUSEHOLDS ARE KEY TO THE NEXT PHASE OF JAPAN’S “VIRTUOUS CIRCLE” OF
REFLATION

Households’ shift to reflationary behaviour: much awaited, not yet realised
There are compelling reasons to believe that households will oblige and increase their consumption. Even if
consumption growth increases by a modest gradient, it would occupy a large share of Japan’s GDP, making it more
powerful than an equivalent expansion in net exports. The other part of household behaviour that may show areflationary pivot is household investment. Although building up cash savings—even in a zero interest rateenvironment—is fully rational in a deflationary economy, doing so amid even mild reflationary conditions is not.
Households were long under-invested in financial markets by global comparison (see Chart 4). However, reflation
provides a monetary incentive for households to participate in financial markets and to seek returns at least capableof keeping up with inflation.
Chart 4: Comparison of household balance sheets

Source: BOJ. Data as at August 2023.

On this front, the new Nippon Individual Savings Account (NISA) regulations that took effect in 2024 are well timed.
Not only do NISA's tax benefit incentives encourage the accumulation of long-term savings in financial market
instruments, but they also provide incentives for market entry in the current year. In addition, they open the door to
the exponential benefits of compounding over time, a phenomenon that Western market players often refer to
as “the eighth wonder of the world”. The enhanced NISA program’s focus on cumulative savings benefits householdbalance sheets. It encourages “dollar cost averaging” behaviour, as opposed to the “theme rotation” strategy
popular among active household investors. This discourages “market timing”, a strategy that both institutional
investors and households often struggle to execute consistently, leading to poor results.

Another piece of the puzzle: financial literacy
Japanese households’ lack of interest in financial markets may soon change once they realise they have been missingout as Japanese indices break consecutive historical records. Nonetheless, old habits die hard, and the deflationary
mindset prevalent among households may require particular effort to overcome. One area where deflation has
eroded household interest and capability to participate in financial markets has been household financial literacy.

YOUR GOALS, OUR COMMITMENT.

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WHY HOUSEHOLDS ARE KEY TO THE NEXT PHASE OF JAPAN’S “VIRTUOUS CIRCLE” OF
REFLATION

Chart 5: Japanese financial literacy by age
Percentage of questions answered correctly
100

(%)

80
60
40
20
0
Interest

Inflation
<35

Risk

36–50

51–65

Overall>65

Source: Sticha, Andrea, & Shizuka Sekita (2023). The importance of financial literacy: Evidence from Japan. Journal of Financial Literacy andWellbeing 1, 244–262. https://doi.org/10.1017/flw.2023.9

Chart 5 illustrates simple measures of financial literacy, focusing on three key topics: interest, inflation and risk. It
shows that a clear divide in financial literacy exists between older and younger households, with deflation and zeroto negative interest rates likely to have curtailed the understanding of key financial concepts among the younger
generations.
Insufficient financial literacy may be one reason why significant participation by households is yet to be observed.
Greater participation, once it occurs, may bring significant benefits to households; it could also aid the overall
development of financial markets. In the US, gradual policy shifts favouring greater participation by households infinancial markets—such as ERISA, the growth of defined contribution programs, the Pension Protection Act of 2006,
the Secure Act and Secure Act 2.0—have greatly increased the demand for financial market assets (Chart 6).
Chart 6: US retirement savings legislation history and household financial participation

38%
36%
34%
32%
30%
28%
26%
24%
22%
20%
18%

US Pension Protection Act: 2006

ERISA: September 1973

Jun-2023

Jun-2020

Dec-2021

Jun-2017

Dec-2018

Jun-2014

Dec-2015

Jun-2011

Dec-2012

Jun-2008

Dec-2009

Jun-2005

Dec-2006

Jun-2002

Dec-2003

Jun-1999

Dec-2000

Jun-1996

Dec-1997

Jun-1993

Dec-1994

Jun-1990

Dec-1991

Jun-1987

Dec-1988

Jun-1984

Dec-1985

Jun-1981

Dec-1982

Jun-1978Dec-1979

Jun-1975

First 401k: 1981

Dec-1976

200,000
180,000
160,000
140,000
120,000
100,000
80,00060,00040,00020,0000

Dec-1973(USD billion)

Participation of US households in equities and mutual funds

Federal Reserve Flow of Funds (FOF) US households & NPOs proprietors investment in unincorporated business assets (LHS)
FOF Households & NPOs mutual fund share holdings assets (LHS)
FOF households & NPOs corporate directly held equities assets (LHS)
FOF households & NPOs gross assets (LHS)
Equities and mutual funds % household balance sheet (RHS)
Source: Bloomberg, US Federal Reserve, Nikko AM Global Strategy. Data as at 24 February 2024.

Considering that Japan remains a developed economy with a mature household likely to spend time and money on
education, we can assume that the generational gaps in financial literacy may be bridged over time. Nonetheless,this is likely an area both the government and BOJ will be keenly monitoring for signs that the “virtuous circle” remains
in motion.
YOUR GOALS, OUR COMMITMENT.

4

WHY HOUSEHOLDS ARE KEY TO THE NEXT PHASE OF JAPAN’S “VIRTUOUS CIRCLE” OF
REFLATION

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REFLATION
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