The global stock market began a relay decline last Friday, and the Japanese stock market was hit the hardest. The Nikkei 225 Index plummeted 12.4% on Monday, the biggest one-day decline since “Black Monday” in 1987. Other Asian, European, and American stock markets also fell one after another.

Some analysts have pointed out that the decline in global stock markets is not only a correction to overvalued technology stocks, but may also mark the time for the settlement of America and Japan's decade-long loose monetary policies. Exactly how fast and how intense this liquidation will be is still unknown.

The ripple effect triggered by Japan's interest rate hike

The direct reason for the sharp decline in the Japanese stock market is that monetary policy and the yen exchange rate have been reversed for a long time.

The Bank of Japan unexpectedly announced an interest rate hike to 0.25% last Wednesday and proposed a schedule to gradually reduce quantitative easing. Bank of Japan Governor Kazuo Ueda made a very clear statement on the exchange rate issue: part of the reason for raising interest rates was to curb the depreciation of the yen.

Some analysts pointed out that after experiencing an ultra-loose monetary policy for nearly 17 years, Japan's continuous aggressive interest rate hikes this year have triggered predictable and necessary risk repricing.

In particular, the long-term extremely low interest rate in Japan and the large interest rate difference with the US interest rate caused the yen to depreciate sharply in the first half of this year. However, with the Bank of Japan aggressively raising interest rates and the Federal Reserve preparing to cut interest rates, this spread is currently narrowing.

The yen continues to weaken, attracting foreign investors to snap up Japanese stocks. According to economist Jesper Koll, as of March, nearly 1/3 of Japanese stock investors were overseas investors in terms of value. The depreciation of the yen also raised the expected profits of Japanese companies in yen terms.

However, Kazuo Ueda said at the interest rate conference that the era of ultra-low interest rates is over.

It is no coincidence that in this round of sharp decline that began last week, the Japanese stock market once fell all of its gains since this year, while the yen recovered all of its losses during the same period. The yen surged to 144 yen this Monday after falling to a low of around 162 last month.

J.P. Morgan Chase pointed out in a report this week that this wave of Japanese stock sell-offs was mainly driven by foreign investors.

The next trigger may be the withdrawal of Japanese investors from overseas markets. Low interest rates in the early period and the weak yen boosted a large number of arbitrage transactions, that is, borrowing cheap yen and investing in higher-yielding dollar assets. The appreciation of the yen indicates that the arbitrage trading environment has begun to reverse, and foreign capital markets, including US Treasury bonds, need to prepare for the withdrawal of Japanese capital.

The Federal Reserve's long-term loose interest rate environment will also usher in liquidation

So what about investors' concerns about the US recession?

This concern is real. Wall Street accuses the Federal Reserve of not cutting interest rates at the latest meeting, which later ushered in a bad US non-farm payrolls report and triggered Sam's Law, implying that a recession in the US is imminent. Although it also triggered a sharp drop in US stocks, this fear even spread to European stocks and Asia-Pacific stock markets.

Some analysts pointed out that although the US employment report for July was weak, it did not show a recession-level unemployment rate. And it's hard to judge now. If the Federal Reserve cuts interest rates in July instead of September, how would it be different?

Calls for the Federal Reserve to bail out the market reflect Wall Street's strong dependence on the Federal Reserve.

Once the US Congress is at an impasse on economic policy, it often only reaches an agreement on increasing government spending. Since the 2008 financial crisis, the US economy has largely been maintained by expanding government spending and easing interest rate policies. However, the long-term loose interest rate environment has never been free, nor can it last forever, and will eventually lead to liquidation.

This is one of the reasons why the Federal Reserve had to raise interest rates to curb inflation. Now some of these liquidations are also due to a sharp fall in the stock market.