Japan’s core inflation has returned for the first time in more than a year owing to increased energy prices, giving signals that the country is on its path to reach its inflation target of 2%. Even though the unemployment rate dropped to 3%, its lowest level since 1990's, household spending saw a decline of 1.2%. 

Increasing inflation is the center point of Japan’s economic growth strategy. The country is placing its bets on rising oil prices and a weaker yen to win its long standing battle against deflation. Expectations of a stronger U.S. dollar are expected to make imports costlier for Japan and to push prices up at home (read: Japan ETFs: Compelling Plays in 2017?).

Given the current hawkish outlook of the Fed and increased probability of a rate hike soon in the U.S., the yen could go down against the greenback, and prove to be a relief for Japanese exporters (read: What is Driving Asian ETFs Higher?).

The sustainability of price gains of domestic production is still unclear due to the declining levels of consumer spending. However, the environment seems to have been set for the economy to battle deflation. Considering the present scenario, the following ETF bets on the Japanese economy seem to be good investments:

WisdomTree Japan Hedged Equity Fund (DXJ - Free Report)

This fund is suitable for investors looking for a broad based exposure to the Japanese economy. It tracks the WisdomTree Japan Hedged Equity Index. This fund is mostly large cap-centric and a pure play against the Japanese equities and the whole economy as such. The fund is dominated by Consumer Cyclical, Industrials, Financial Services, Technology and Basic Materials having more than 80% of asset allocation. 

The fund charges 48 bps as fees and manages $8 billion as AUM. It has a year-to-date return of 4.80% and a one-year return of 22.05%. As such, DXJ currently has a Zacks Rank #1 (Strong Buy) with a Medium risk outlook.

Deutsche X-trackers MSCI Japan Hedged Equity ETF (DBJP - Free Report)

This ETF is appropriate for investors looking for a tactical tilt toward the Japanese economy or looking for a country rotation strategy. The fund tracks the MSCI Japan US Dollar hedged Index. It’s mostly large cap-centric and heavy on Consumer Cyclical, Industrials, Financial Services and Technology, having more than 65% of assets invested. 

The fund is relatively less concentrated on its top 10 holdings with about 20% invested in the same. The fund manages AUM of $2.08 billion and has an expense ratio of 45 bps. It has a year-to-date return of 2.96% and a one-year return of 15.93%. As such, DBJP currently has a Zacks Rank #1 with a Medium risk outlook.

iShares Currency Hedged MSCI Japan ETF (HEWJ - Free Report)

This fund is the appropriate bet for investors looking to gain a diversified equity exposure to the Japanese economy. The fund tracks the MSCI Japan 100% Hedged to USD Index. It’s mostly large cap-centric and heavy on Consumer Cyclical, Industrials, Financial Services and Technology, having more than 65% of assets invested. 

The fund manages AUM of $858 million and has an expense ratio of 48 bps. It has a year-to-date return of 3.13% and a one-year return of 16%. As such, HEWJ currently has a Zacks Rank #1 with a Medium risk outlook.

Bottom Line

It seems like Japan is crawling toward its 2% inflation target. Given the current outlook for the Japanese economy, higher probability of a Fed rate hike and a weakening Yen, it’s best to obtain a currency hedged exposure to these funds, in order to get exposure to the equities of the world’s third largest economy.