Source: Quan Shang Guo , Author: Shi Qian

Just now, the Japanese stock market suddenly plummeted. The Nikkei 225 Index fell sharply after opening and the decline quickly expanded to more than 2.5%. Yesterday, the peripheral markets led by the US stock market were strong, and the South Korean market performed well this morning. So what exactly happened?

Analysts believe that there may be two main reasons. Firstly, the continuous appreciation of the yen has broken through the key position of 150 between the US dollar and the yen this morning, which has exceeded the psychological price of foreign exchange market investors to a certain extent. Many people previously believed that the appreciation of the yen was limited. This has also raised doubts about the Japanese economy in the market. The second is the seesaw effect beginning to emerge. Since this year, the Japanese stock market has risen significantly. Against the background of Japan's interest rate increase, large international funds may begin to flow to lower places. For example, foreign investment yesterday net inflowed A shares by nearly 20 billion yuan.

Unexpected scene in the Japanese stock market

While the NASDAQ index in the US stock market soared and the main global markets rose across the board, there were problems in the Japanese stock market. This morning, the Japanese market fell sharply across the board, and the Nikkei 225 Index and TOPIX Index both fell more than 3%.

So what happened? On July 31st, the Bank of Japan announced a short-term interest rate hike from 0-0.1% to 0.25% with a vote of 7 to 2. The Bank of Japan also announced a detailed policy for reducing its balance sheet, with the scale of government bond purchases being reduced by 400 billion yen per quarter and monthly bond purchases from January to March 2026 being approximately 3 trillion yen.

At the same time, official data released on Wednesday showed that Japan's authorities invested 5.53 trillion yen (about 36.8 billion US dollars) to support the yen in July. Against this background, the yen rose above 150 this morning.

From the recent market trends, the Japanese stock market has mostly been weak during the appreciation of the yen. Analysts believe that this yen interest rate hike may deepen the market's doubts about the Japanese economy, which is reflected in three aspects: first, mortgage pressure will increase, young people's living pressure will increase, and consumer spending will be affected; second, corporate loan interest rates will also rise, increasing corporate operating costs; third, Japan is also an export-oriented economy, although the appreciation of the yen caused by interest rate hikes is conducive to imports, exports may be affected.

However, the overall CPI and core CPI excluding energy in Japan have exceeded the target inflation rate of 2% for 27 consecutive months. The price rise in Japan is obviously the reason for the Bank of Japan's decision to raise interest rates. Tianfeng Securities believes that the high price of Japan is behind the slow repair of domestic demand consumption and the impact of depreciating the yen. Therefore, in the situation of suppressing inflation caused by exchange rate depreciation, the Bank of Japan is facing a situation where it must raise interest rates within this year. It's just that in the choice of timing, the Bank of Japan chose to raise interest rates early.

Expectations for the yen

So, where will the yen go? This morning, the strong yen is both inherent to Japan and related to the US Federal Reserve's release of the rate cut signal.

On March 19th of this year, the Bank of Japan decided to end its negative interest rate policy and raised the policy rate from -0.1% to within the range of 0-0.1%, the first interest rate hike by the Bank of Japan since February 2007, 17 years ago. However, this interest rate hike did not bring negative impacts and the yen continued to depreciate. During this round of interest rate hikes, due to the relatively high benchmark interest rate in the United States, although the Bank of Japan initiated an interest rate hike, the absolute value of the interest rate difference between the US and Japan is relatively large, and there are frequent carry trade transactions, so the yen still depreciates.

Ping An Securities believes that looking ahead, the yen's short-term appreciation trend may be maintained, but the overall duration is limited. Under the background of the continuous deviation of US and Japan monetary policies in 2023, the interest rate difference between the United States and Japan will gradually expand, with the interest rate difference reaching a high of 4.6% on November 3rd 2023, causing capital to flow out of Japan in the short term, pushing down the yen.

In this round of interest rate hikes combined with a clear trend towards a US Federal Reserve rate cut in September, the US-Japan interest rate gap will further narrow, and the current net short position of yen carry trade may continue to close, allowing the yen to maintain its appreciation trend in the short term. But given the limited hike this time, US-Japan interest rate spreads will still be high, and carry trade logic will continue, limiting the overall appreciation of the yen.

Kyohei Morita, Chief Economist of Nomura Securities, and Yujiro Goto, Head of Foreign Exchange Strategy, wrote in their report that the Bank of Japan may raise interest rates again at its monetary policy meeting in April 2025, and the policy interest rate will be raised by 25 basis points to 0.50%.

How will the equity market go?

Equity markets may also be affected by the movement of the yen. Previous yen interest rate hikes have triggered global stock market crashes, such as the bursting of the dot-com bubble after 2000 and the financial crisis after 2007. From a financial perspective, it is also because the framework of yen arbitrage trading has been disrupted.

But this time the expectation seems to be somewhat different. In the press conference, the governor of the Bank of Japan, Kuroda Haruhiko, did not make a clear hawkish stance. In the short term, the BOJ chose a 15bp rate hike instead of a 10bp rate hike. Tianfeng Securities believes that this in a sense exhausts the policy space for the full year of 2024 and can be seen as a bearish signal. Combining with the analysis of Ping An Securities, this seems to mean that the market does not seem to have too high expectations for sustained significant depreciation of the yen. And under the background of the large interest rate differential between the United States and Japan, the yen arbitrage framework may not be greatly affected in the short term.

However, it is worth noting that the A-share market saw nearly 20 billion yuan in net foreign buying yesterday. This indicates that international capital may have begun to switch between high and low, and in this process, a seesaw effect may also occur. Compared to the Japanese market, the current valuations of A-shares and Hong Kong stocks are indeed much cheaper.

Editor/Lambor