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Markets Just Can’t Get Enough of the Abe Trade

Photo: Gyro Photography | Amana Images | Getty Images

Reports that Japan's government will likely nominate Haruhiko Kuroda, an advocate of aggressive monetary easing, as the next Bank of Japan (BOJ) chief, do not come as a surprise. So the fact that the yen has slumped and stocks are surging on the news goes to show markets cannot get enough of the "Abe trade."

Placing bets that the yen will continue to slide, while Japanese shares will extend a bull run as Japan's new Prime Minister Shinzo Abe makes a bid to revive the world's third largest economy are expected to remain a favored trade despite talk of a correction or pull-back.

(Read More: Look Out! Correction Looms for Soaring Nikkei)

On Monday, the yen slumped more than 1 percent against the U.S. dollar to its lowest level since May 2010 and the benchmark Nikkei index soared 2 percent on expectations that a BOJ led by Kuroda, currently Asian Development Bank President, will push for a more unorthodox monetary policy to achieve the 2 percent inflation target adopted last month.

"We've had dollar/yen move up to new highs today [Monday] and it is interesting that it has moved higher on well-documented news," said Royal Bank of Scotland currency strategist Greg Gibbs, referring to reports of a Kuroda nomination. "This just shows that the market is still responding to the policy shift in Japan."

Japan's government is expected to nominate Kuroda and make its suggestions for two deputy governor posts to parliament this week. The incumbents are due to step down on March 19.

The yen, trading at about 94 per dollar, has weakened about 10 percent so far this year, making it the world's worst performing major currency, followed by the British pound, which has shed about 7 percent of its value against the greenback.

Japanese shares, meanwhile, have surged about 10 percent so far this year and more than 20 percent over the past three months as the weak yen boosts the outlook for exporters.

"The main take away from the news that Kuroda is likely to be nominated as next BOJ Governor is that Abe is putting his money where his mouth is," said Vishnu Varathan, market economist at Mizuho Corporate Bank in Singapore. "Until we see 'Abenomics' stumble, markets will remain smitten with the whole Japan revival story."

(Read More: Why You Should Look Past Japan's GDP Miss)

"Abenomics" is the word now widely used to describe the economic policies of Prime Minister Shinzo Abe, who came to power following elections in December and which are seen as a radical departure for Japan.

Most analysts maintained calls for the yen to keep weakening against the greenback. Societe Generale for instance, expects the dollar to rise to 100 yen this year and 110 yen further out.

Dovish BOJ

Kuroda, a former official at Japan's finance ministry, has long criticized the BOJ for being too slow to expand monetary stimulus.

The government is also expected to nominate economics professor Kikuo Iwata, a vocal advocate of an aggressive monetary policy, to one of the two deputy BOJ governor posts, according to Japan's Nikkei newspaper. The other deputy governor post is expected to go to a central bank official.

Analysts said acceptance of the nominations, which must be approved by both houses of parliament, are not a given since the ruling coalition government led by Abe's Liberal Democratic Party does not have a majority in the upper house of parliament.

Still, there were some positive signs for Abe on Monday: Japan's Jiji news agency quoted a senior member of the main opposition party, the Democratic Party of Japan, saying Kuroda met its criteria for BOJ Governor so he would be hard to oppose.

"Some people may think that a pull-back is on the cards, but more importantly, what we get with Kuroda is how the market is already reacting – which is that the yen becomes weaker, " Donald Hanna, managing director at Fortress Investment Group told CNBC Asia's "Cash Flow."

(Read More: An Aggressive Bank of Japan Sooner Than You Think)

Asked whether he believed in "Abenomics," Hanna said: "Yes, both the rise in Japanese shares and the rise in dollar/yen, has been an element of our strategy for some months. The change in Japan is material."

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