Japan's market suffered through the recent market rout along with the rest of Asia's stocks, but its shares may actually get a fillip from a Federal Reserve rate hike.
"The single most important driver of equity performance in the next year or so is likely to be renewed weakness in the yen," Julian Jessop, chief global economist at Capital Economics, said in a note Tuesday. He expects the Nikkei will hit 23,000 by the end of 2016; the index was trading around 18,135 Wednesday.
Jessop sees two drivers of further yen weakness: expectations the Bank of Japan (BOJ) will expand its quantitative easing program, possibly as soon as next month, and a Fed hike.
The lady or the tiger drama around whether the Fed will increase interest rates for the first time in more than nine years at its meeting this week helped drive a global market selloff amid concerns over tightening liquidity.
But Jessop estimates that if the spread between the two-year U.S. and Japanese government bond yields widens to one percentage point - it's currently around 70 basis points - that would justify the yen falling to his end-2016 forecast of 140 against the U.S. dollar, from around 120.20 Wednesday, and thus driving the Nikkei higher.
A rise in U.S. bond yields relative to Japan's makes Japanese assets less attractive, helping to spur outflows that weaken the yen; a weaker Japanese currency typically boosts the country's stocks as it makes exports more attractive and overseas earnings look plumper when they are translated back into yen.
To be sure, the Japan market has already had quite a rally, surging nearly 75 percent since the beginning of 2013 and up nearly 4 percent so far this year despite doubts over whether Abenomics, as Prime Minister Shinzo Abe's plan to kickstart Japan's economy out of its decades-long deflationary slump is known, will see any success.