Fundamentals or Expectations? Explaining Japan’s Nikkei 225 Surge through Macroeconomic Evidence

Alisa Gao

Historical Background

In the 1990s, the value of land in Japan exceeded four times of all land in the United States (1). At the time, many believed Tokyo to be the centre of the world and assumed that real estate prices would continue rising indefinitely. When prices rise far above their fundamentals, leaving only speculation on the surface, every apparent prosperity carries a finite lifespan, waiting for the inevitable burst. A few years later, the bubble burst: pessimism spread, stock markets panicked, and land values plummeted. Japan entered the “Lost Decades”, characterised by a deflationary mindset and prolonged economic stagnation.

Recent Revival and Research Question

Recently, Japan has begun to show signs of revival. The Nikkei225 doubled between 2023 and 2025 (2), raising the question of whether the equity market rally reflects genuine improvements in real economic fundamentals.

To investigate the drivers of the Nikkei 225 surge, I constructed a multiple regression model. Although many factors may influence the index, the model includes four key macroeconomic variables: monthly regular salary, export revenue, the USD/JPY exchange rate, and the 10-year Japanese government bond yield.

Monthly regular salary captures strength of domestic demand, which can support corporate revenues and valuation, while export revenue measures external demand. Yen depreciation against the US dollar primarily reflects currency translation effects rather than fundamental recovery. Meanwhile, the 10-year JGB yield serves as a proxy for monetary policy stance and market expectations. I interpret the surge in stock price to be fundamentally driven if β1 and β2 are positive and significant. Conversely, if β3 and β4 are positive and significant, expectations may dominate without corresponding improvements in real fundamentals.

Level Regression Results and Interpretations

Nikkei 225t = α + β1 Waget + β2 Exportst + β3 USD/JPYt + β4 JGBYieldt + εt

Between December 2020 and December 2025, the model demonstrates strong explanatory power, with an adjusted R square of 0.8512. β1 and β4 are positive and statistically significant, while β2 and β3 are negative and insignificant. This suggests that export growth and yen depreciation are not primary drivers of the Nikkei 225 surge.

Notably, the regular wage level has a p-level of 0.000258, providing very strong evidence that wage levels and the Nikkei 225 are related. The equity market recovery therefore appears closely tied to improvements in domestic income and demand rather than external factors.

Table 1. Level Regression Result

The positive coefficient on bond yield suggests that rising interest rates are interpreted as monetary policy normalisation - positive signal for stronger growth expectations - rather than constraint on economic activity.

Interest Rate in Japan: A Contradiction to Conventional Theory

The relationship between interest rate and stock performance in Japan contradicts the traditional hypothesis that interest rate hikes depress equity prices. Under the conventional view, higher borrowing costs discourage investment and consumption, resulting in weaker capital expenditure and domestic demand (3). Reduced capital investment may worsen firms’ future growth prospects and lead to a less favourable earning outlook, thereby exerting downward pressure on equity valuations. In Japan, suffering from decades of deflation, interest rate hikes can tell a very different story. The central bank, as a trusted and authoritative institution, is perceived to raise rates only when it is confident in the resilience of the economy. If policymakers tighten despite potential growth risks, such actions may signal strong domestic demand and improving economic fundamentals (4).

However, multicollinearity may exist between regular wage levels and JGB yields, as the central bank may respond to rising labour costs with interest rate hikes to curb inflation.

In December 2025, the BoJ raised its policy rate to 0.75%, the highest level in three decades (5). Japan’s current inflation can be partly attributed to cost-push pressures arising from rising labour wages. Labour shortages have strengthened workers’ bargaining power in wage negotiation, with major unions seeking wage increases exceeding 5% during the 2026 shunto (6). In response, the central bank raised interest rates to prevent underlying inflation (7), implying that interest rates may move in response to inflationary dynamics and thus affect JGB yields.

Together with the BoJ’s 2024 estimate of the neutral rate at between 1% and 2.5% (8), these developments form a clear expectation that the bank will continue to raise policy rates and proceed with monetary policy normalisation.

Growth Rate Regression Result and Interpretations

rNikkei 225,t = α + β1 rWage,t

+ β2 rExport,t + β3 ΔUSD/JPYt

+ β4 ΔJGBYieldt + εt

To examine period-to-period changes, I then conduct a growth-rate regression. This specification is designed to capture short-term market responses to new information. The result from Table 2 shows that none of the variables show a statistically relationship with Nikkei 225 growth, implying that such short-run dynamics play a limited role in explaining market movements. The significance of wage levels in Table 1 therefore supports the interpretation of a structural recovery driven by domestic fundamentals rather than transient market reactions.

Table 2. Growth Rate Regression Result

However, since there could be many unobservable and unquantifiable factors influencing Nikkei 225 price, like traders’ psychological mindset, the regression results in Table 1 should be interpreted as evidence of structural improvement rather than a causal relationship between wage growth, JGB yields and equity prices. Expectations of a positive economic outlook arising from policy normalisation may already be priced into the market. As such, even if interest rates continue to rise, there is no guarantee that stock prices will increase, as anticipated future gains may already be reflected in current valuations.

Policy Outlook and Risks

From another perspective, although we cannot fully attribute the stock market surge to improvements in real economic fundamentals, it may reflect expectations of future prospects. The results suggest that this positive outlook is closely linked to strengthening domestic demand.

Upcoming fiscal spending packages totaling 17.7 trillion yen could further reinforce this outlook by stimulating domestic consumption (9). On the other hand, the market may be less responsive to external demand shocks. External risks - including potential U.S. tariff policies under the Trump administration and ongoing geopolitical tensions with China - may not immediately depress market expectations.

At the same time, concerns remain regarding fiscal sustainability. The new prime minister, Takaichi, advocates high government spending despite Japan’s public debt already exceeding 230% of its GDP (10). Rising interest rates may significantly increase debt-serving costs, posing long-term fiscal risks that could eventually weigh on economic stability (11).

References

Cutts, Robert L. 1990. “Power from the Ground Up: Japan’s Land Bubble.” Harvard Business Review. May 1990. https://hbr.org/1990/05/power-from-the-ground-up-japans-land-bubble?.
Nikkei Industry Research Institute. 1949. “Nikkei Stock Average, Nikkei 225.” FRED, Federal Reserve Bank of St. Louis. May 16, 1949. https://fred.stlouisfed.org/series/NIKKEI225.
Bernanke, BEN S., and KENNETH N. Kuttner. 2005. “What Explains the Stock Market’s Reaction to Federal Reserve Policy?” The Journal of Finance 60 (3): 1221–57. https://doi.org/10.1111/j.1540-6261.2005.00760.x.
Ito, Takatoshi, and Frederic Mishkin. 2006. “Title: Two Decades of Japanese Monetary Policy and the Deflation Problem” ISBN: 0–226. https://www.nber.org/system/files/chapters/c0092/c0092.pdf.
Lewis, Leo. 2025. “Japan Raises Interest Rates to Highest Level in 30 Years.” @FinancialTimes. Financial Times. December 19, 2025. https://www.ft.com/content/cbaaff02-9c62-4f5f-8e02-d38798df4196.
“Early Signs for Japan 2026 Wages Bolster Case for Near-Term BOJ Rate Hike | the Asahi Shimbun: Breaking News, Japan News and Analysis.” 2026. The Asahi Shimbun. 2026. https://www.asahi.com/ajw/articles/16179071.
Kihara, Leika. 2026. “BOJ Policymaker Calls for Timely Rate Hike to Manage Inflation.” Reuters, February 6, 2026. https://www.bloomberg.com/news/articles/2025-12-04/boj-can-only-gauge-neutral-rate-within-wide-range-ueda-says.
Nohara, Yoshiaki. 2025. “BOJ Can Only Gauge Neutral Rate within Wide Range, Ueda Says.” Bloomberg.com. Bloomberg. December 4, 2025. https://www.bloomberg.com/news/articles/2025-12-04/boj-can-only-gauge-neutral-rate-within-wide-range-ueda-says.
Yokoyama, Erica. 2025. “Japan Confirms Deeper GDP Decline, Backing Stimulus Package.” Bloomberg.com. Bloomberg. December 8, 2025. https://www.bloomberg.com/news/articles/2025-12-08/japan-confirms-deeper-gdp-contraction-backing-stimulus-package?sref=TtzswLLC.
Trading Economics. 2019. “Japan General Government Gross Debt to GDP.” Tradingeconomics.com. TRADING ECONOMICS. September 5, 2019. https://tradingeconomics.com/japan/government-debt-to-gdp.
Yamaguchi, Takaya. 2026. “Exclusive: Japan’s Debt Issuance to Surge 28% in Fiscal 2029 from 2026, Finance Ministry Estimates.” Reuters, February 17, 2026. https://www.reuters.com/world/asia-pacific/japans-debt-issuance-surge-28-fiscal-2029-2026-finance-ministry-estimates-2026-02-17/.

Regression Data Source

Federal Reserve Economic Data - Nikkei 225, 10-year JGB yield

MicroMacro - Japan Export Value, Japan monthly regular wage, USD/JPY