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Thought of the day

Japanese equities took a breather on Tuesday after a strong run, as investors took stock of the first meeting between US President Donald Trump and Japan’s new prime minister, Sanae Takaichi. The two got off to a warm start in their Tokyo summit, with Trump praising Takaichi as “great” and “a big deal,” and calling Japan “an ally at the strongest level.” The Japanese PM in turn reportedly plans to nominate Trump for the 2026 Nobel Peace Prize, according to a White House spokesperson.

Several deals were struck. The two leaders announced a framework agreement to secure critical minerals and rare earths and coordinate on stockpiles, in a bid to accelerate diversification of supply from China over the next six months. A second document was signed relating to a Japanese pledge to invest USD 550bn in the US, though the document itself was reportedly only one page and scant on details. Other areas of focus included plans to boost Japanese defense spending and to expand imports of US vehicles, energy products, and agricultural goods.

While the actual impact of these agreements and framework will take time to come into view, we see several initial takeaways for investors:

Warm US-Japan ties reduce policy risk. The cordial relationship between President Trump and Prime Minister Takaichi, underscored by personal gestures and references to former PM Abe, has set a very positive tone for bilateral relations. President Trump has shown some unpredictability with close allies, but strong personal ties at the leadership level should help reduce the risk of sudden negative policy catalysts, as has been experienced by other US trading partners. This should allow investors to look past some of the tail risks around US trade policy, suggesting a more stable investment backdrop for Japanese assets.

Japan to boost defense spending, but fiscal priorities stay intact. Trump publicly called for Japan to raise defense spending to 5% of GDP prior to the trip, but does not appear to have pressed it further. PM Takaichi did preempt the issue last week, fast-tracking the timeline to increase defense spending to 2% of GDP by several years. Given her coalition’s slim majority and ongoing commitments to broader fiscal stimulus, we do not expect defense outlays to crowd out other government spending. Targeted increases, potentially including an investment to expand US shipbuilding capacity, should be relatively complementary to Japan’s pro-growth agenda. Japanese government bond yields fell Tuesday after US Treasury Secretary Bessent made no Bank of Japan policy demands in his meeting with Japan’s finance minister, boosting market confidence in Japan’s fiscal discipline.

Rare earth framework confirms need for joint government support. The six-month timeline to identify and launch joint projects looks notable, given US calls for China to pause its own rare earth exports curbs for one year as part of a trade truce agreement. Similar deals and frameworks have been reached in Southeast Asia and Australia. However, meaningful change will be challenging: China accounts for 91% of global rare earth refining, according to IEA estimates from last year, and its latest export restrictions on specialized rare earth processing equipment will constrain other markets seeking to ramp up. Only recently have some ex-China producers demonstrated the capability to refine the heavy rare earths needed for advanced magnets, with clear challenges ahead in execution, scaling up, and achieving cost-effectiveness. We take this deal as recognition that coordinated government support and subsidies will be essential to make headway, with miners hesitant to ramp up production without clear commitments by refiners outside China to process rare earths.

So while some profit-taking may be natural after the Nikkei’s near 26% rally year-to-date, we expect the market to continue to rise, supported by expansionary fiscal policy under Takaichi, only modest rate hikes, and ongoing corporate reforms. We anticipate more momentum to unwind cross-shareholdings, accelerate share buybacks, and encourage business portfolio restructuring, all of which should improve firms' return on equity (ROE) and profit margins. We maintain our Attractive rating on Japanese equities, favoring IT services, real estate and machinery, and government-supported sectors like defense, IT, and medtech. Little was said about the yen or the pace of rate hikes, previously a sore point for the US side, though US Secretary Treasury Bessent in separate meetings called on his counterpart to pursue "sound monetary policy." Our quarter-end USDJPY forecasts remain at 152, 150, 148, and 145 through September 2026.