With Japan’s long-term interest rates briefly exceeding 3.0%, views are emerging that the stock market faces three headwinds. Higher borrowing costs, fund flows into safe-haven assets and a reassessment of growth-stock valuations could affect the market as a whole.
Japan’s financial markets have entered a period of rising long-term interest rates, with the yield on newly issued 10-year Japanese government bonds exceeding 3.0% at the beginning of this month. As the market enters a historic period of transition, the focus is on what structural changes a world with interest rates will bring to the equity market.
The headwinds that rising interest rates create for the stock market can be broadly grouped into three categories. First, higher borrowing costs put pressure on corporate earnings, making capital-intensive industries more likely to reduce capital investment and experience weaker-than-expected results.
Second, as the appeal of safe-haven assets increases and the option of earning a certain yield on safe government bonds returns, funds from institutional investors and others may move from equities into bonds, creating a risk of reduced liquidity across the market.
Third is the impact on equity valuations. When the interest rate used as the discount rate rises, the present value of future earnings is estimated to be lower, and growth stocks in particular may be more prone to share-price corrections.