Many of Asia's major economies rank among the most vulnerable to the energy shock from the Middle East conflict, a reality reflected in the sharp equity market sell-offs across the region when the war began in late February.
While most indices have since recovered on fundamentals and signs of de-escalation, my recent business trip to Japan and Korea made clear that the region remains on edge. Uncertainty around the conflict's impact on energy supply has not dissipated.
Japan's exposure is structural. Crude oil accounts for around 30% of the country's total energy consumption, with approximately 90% of imports sourced from the Middle East—principally Saudi Arabia and the UAE. Japan is also one of the largest LNG importers among developed economies, though its LNG supply chain is more geographically diversified, offering a partial offset to its concentrated crude oil dependency.
Resilient Factors
The near- and medium-term impact of the conflict on energy supply will have weighed on the Bank of Japan's deliberations at its meeting this week, where it is expected to leave interest rates unchanged, preserving optionality ahead of June as the inflationary effects of the energy shock become clearer.
What has helped is that oil prices have retreated from their early April highs, supported in part by flows through the Saudi East-West pipeline, which has prevented prices from reaching more alarming levels. Our base case remains that demand destruction does not materialize until oil sustains $150 – $175 a barrel for six months or more. At the time of writing, oil was trading in the mid-$90s.
Beyond the oil price, Japan's macro buffers have provided meaningful insulation. The country holds approximately 250 days of strategic oil reserves—one of the largest buffers in Asia and among developed economies—and the government moved swiftly to reinstate gasoline subsidies, cushioning the consumer impact and limiting the scale of the equity sell-off relative to regional peers.
Constructively Positioned
While Japan remains one of the most exposed developed economies to the conflict, we remain constructive and our overweight in Japanese equities is unchanged. My recent visit reinforced rather than challenged that view.
The long-term investment case rests on several important factors. Corporate governance reform continues to gain traction, with a deepening focus on shareholder value driving a structural improvement in return profiles. The economy is strengthening on stabilizing inflation and meaningful gains in real wage growth while companies with pricing power are able to pass on higher input costs to protect margins. Reinforced by a resounding election victory, Prime Minister Takaichi's economic and fiscal policies are broadly supportive, particularly in strategic sectors including AI, defense and shipbuilding.
The snap election in February delivered a decisive majority, reducing policy uncertainty and providing the kind of political continuity that has historically been a tailwind for Japanese risk assets—most notably during the Koizumi and Abe periods. The Nikkei 225 index is up about 18% in dollar terms year-to-date and around the same in local currency, making it one of the best-performing major markets this year.
Long-Term Attraction
The risks to this outlook are, however, very real. The Middle East conflict and its effect on global energy prices remain the primary concern. Yen volatility is another. And a less discussed but potentially significant risk lies in supply constraints on industrial materials—sulfur, helium and related inputs critical to manufacturing processes. Should disruption extend into the summer, Japanese industrial production could face capacity constraints with knock-on consequences for global supply chains.
That said, the foundations underpinning our constructive view are durable. A stable government, substantial strategic reserves, renewed fiscal support, recovering real wages and a corporate earnings cycle that remains structurally positive provide a platform for recovery as the macro environment stabilizes.
Beyond Japan, the vested interests pushing toward de-escalation in the Middle East are substantial, spanning energy importers, exporters and major consumers alike. Our base case remains that the Strait situation resolves. The range of outcomes is wide, but absent a breakdown in negotiations or a sharp move higher in oil, we remain constructive on Japan and on global growth and risk assets more broadly.
What to Watch For
Tuesday 04/28:
- Japan BoJ Interest Rate Decision
- U.S. CB Consumer Confidence
Wednesday 04/29 :
- U.S. Federal Reserve Interest Rate Decision
- Canada BoC Interest Rate Decision
- German Consumer Price Index
- U.S. Durable Goods Orders
- U.S. Crude Oil Inventories
- China Manufacturing Purchasing Managers’ Index
Thursday 04/30:
- Eurozone ECB Interest Rate Decision
- U.K. BoE Interest Rate Decision
- German GDP
- Eurozone Consumer Price Index
- U.S. Core PCE Price Index
- U.S. GDP
- U.S. Initial Jobless Claims
- U.S. Chicago Purchasing Managers’ Index
Monday 05/01:
- U.S. ISM Manufacturing Purchasing Managers’ Index
- U.S. ISM Manufacturing Prices