US Stock Plunge Fuels Nikkei Slide; Yuan, Yen Climb
The Japanese stock market, which has seen a remarkable surge of interest from global investors over the past two years, has recently been hit by sharp declines. On August 2nd, a wave of panic selling swept through the market, causing the Nikkei 225 index to close down by 5.81%, marking a significant drop to 35,909.7 points, the lowest since February 7. Similarly, the Tokyo Stock Exchange's index fell by 6.1%, representing the largest drop since 2016. This sudden downturn has raised eyebrows across financial circles, leading many to reflect on the underlying causes and implications for other markets in the Asia-Pacific region.
On the same day, markets in the Asia-Pacific also experienced declines, with the Hong Kong Hang Seng Index dropping more than 2%. Interestingly, this market downturn coincided with an appreciation of several Asian low-interest currencies, such as the Japanese yen and the Chinese yuan. For instance, during the afternoon trading session on August 2, the US dollar fell below 7.2 yuan, while the dollar/yen exchange rate dipped below 149 after peaking at around 162 earlier. This intriguing contrast between weak equity markets and strengthening currencies has allowed analysts to speculate on the potential shift in financial dynamics.
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There seems to be a dual factor at play in Japan's recent market troubles: the anticipated interest rate hike by the Bank of Japan and the reactions to the plummeting US technology stocks. Veteran macro trader Yuan Yuwei explained that investors initially expected the Federal Reserve to decrease interest rates, which would benefit tech stocks; however, as the growth in tech began to taper off, this created a sell-off scenario. The Bank of Japan's long-anticipated rate hike, which finally materialized, had the opposite effect on bank and insurance stocks that had thrived during the low-interest environment. Also, the rising yen has posed potential risks for Japan's export sector, causing further market unease.
Indeed, the yen has gained striking value, appreciating nearly 8% against the dollar recently. This surge has pushed the Nikkei to a five-month low, reflecting a broader market pause amid rapid fluctuations. Notably, the Nikkei dropped by 15% over the span of just 16 days, and Friday witnessed its biggest single-day drop since the pandemic. Key sectors tied to exports and tourism, such as the automotive industry and department stores, have felt the brunt of this rapid downturn. Last August, the Nikkei soared by 22%, reaching a peak of 42,426.77 points; yet, it has suffered close to a 10% decline in just the last month.
A foreign exchange trader at a global financial institution voiced the sentiment of many in the market when he remarked, "The market has suddenly recognized that the Bank of Japan is hawkish and, indeed, it's the only major central bank taking a hawkish stance globally." This identification of an unexpected shift in the Bank of Japan’s policy underscores the complexity of the current economic landscape.
Previously, as Jiang Wenjian, head of diversified asset investment at Pictet Asia, pointed out, the robust performance of Japanese equities was largely due to ongoing monetary easing by the Bank of Japan, which weakened the yen and effectively bolstered Japan's exports. This had exciting repercussions for Japan's tourism and service sectors. However, the wind might change as discussions hint that if the yen trends toward appreciation in 2024, it could pose challenges for the stock market, curtailing its growth.
On July 31, the Bank of Japan surprised the market with a 15 basis points interest rate hike, a significant step ahead of the anticipated timelines of September or October. They also unveiled plans to gradually reduce their monthly purchases of Japanese government bonds, aiming to bring the scale down to 3 trillion yen by March 2026. In light of rising wages and increasing household inflation expectations, the shift in policy demonstrates a move toward controlling inflation while managing exchange rate dynamics.
This climate of volatility bore further fruit as the decline of US tech stocks hastened the unraveling of Japanese equities. On the night prior, the Nasdaq 100 experience a staggering drop of 2.44% to 18,890.39 points, losing nearly 9% from its recent peak in July. Investors are acutely aware of the risk that these downward trends create, especially when coupled with a strengthening yen.
For over two weeks, the swift appreciation of the yen against the dollar has led to catastrophic losses for carry trade operations, where traders borrow in low-yielding currencies to invest in higher-yielding ones. As major US technology firms began to report lackluster earnings, further exacerbating market declines, Japanese investors felt the impact as stated by the Chief Investment Officer of PGIM Japan, Marunaka Seiji, highlighting the widening rift in real interest rates between the US and Japan since the Fed initiated its rate hike cycle in March 2022.
As market watchers eyed the performance of small-cap stocks, they noted that the Russell 2000 index surged 9% despite the broader market declines. This behavior points to a significant divergence, particularly as small-cap stocks tend to be more sensitive to domestic economic changes and less impacted by tariffs. The tech sector’s performance faltered, with several prominent companies disappointing investors in their quarterly reports.
Meanwhile, the three major US stock indices plummeted, with the Nasdaq dropping 2.3% and the S&P 500 falling by 1.4%, sending the volatility index (VIX) to 18.6. In Europe and the Asia-Pacific, principal indices mirrored these declines. Except for Meta’s stock, which rose 5% on positive earnings news, most technology giants experienced significant declines due to lackluster forecasts, showcasing the troubling climate for growth stocks.
Aside from these developments within the US, the future of Japan’s monetary policy remains pivotal for its stock market prospects. Following a revision of mid-term inflation forecasts by the Bank of Japan, there's speculation about further rate hikes, with the potential for sustained wage and price growth indicating that Japan's neutral interest rates may require adjustments upwards to stabilize prices.
As global leaders, notably Western central banks, begin a cycle of rate cuts—illustrated by the Bank of England’s recent announcements to lower rates and hints from the Federal Reserve about possible cuts in September—the dynamics around the yen may shift once more. Analysts predict substantial cuts by the Federal Open Market Committee (FOMC) over the coming years, leading to speculation about a potential resurgence of yen bullishness.
Interestingly, despite the dismal stock market performance in Japan, Asian currency markets found unexpected strength, seen in the substantial rebounds of both the yen and the yuan. According to senior analyst Matt Simpson from Gain Capital, the recent surge in the yen has catalyzed a similar move in the yuan as hedge funds leverage the yen as a low-interest currency for carry trades.
While China's economic fundamentals remain crucial for the currency’s performance, the current market momentum bears significant weight. Some traders noted that as market sentiment shifts, beliefs around the yuan breaking previous lows have begun to reverse, signaling potential optimism.
This suggests a crucial relationship between the direction of the dollar/yen exchange rate and the yuan's trajectory. The ongoing strength of the yen is notable amidst a backdrop of contrasting monetary policies between the Fed and the Bank of Japan. As the market continues to navigate these shifts, it remains to be seen whether a bounce in the dollar/yen from key trend lines may serve as a further adjustment to oversold technical indicators or if the downward pressure will persist. Signs currently lean toward a bearish outlook, indicating a potential new low around the 140 mark could emerge if the trend solidifies further.