The Strategist

Turbulence in Japan's financial markets

Financial turbulence in Japan's markets has escalated, with the yen rebounding against the dollar and Japanese stocks plunging into a bear market. The Bank of Japan's decision to raise the policy rate to 0.25% and reduce Japanese Government Bond purchases triggered a significant drop in bond yields. In addition, the authorities signalled that Japan is approaching a new macroeconomic equilibrium with inflation around 2%. Together, these moves led to a sharp yen appreciation and a severe sell-off in the equity market. Going forward, we expect the USD/JPY exchange rate to balance between 140 and 150, although we acknowledge the difficulty of making accurate predictions in times of extreme volatility.

  • Date
  • Auteur Sebastian Petric, LGT Senior FX Strategist
  • Temps de lecture 10 minutes

 

Japan Wirtschaft
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Policy Shifts and Market Reactions

The turmoil in Japan's financial markets escalated on Monday as the yen continued its rebound against the dollar and Japanese stocks plunged into a bear market. Yields on benchmark Japanese Government Bond (JGB) fell by the most in more than two decades. This was triggered by the Bank of Japan (BoJ) raising the policy rate to 0.25% in July and announcing a plan to reduce JGB purchases.

Market Dynamics and Future Outlook

In July, the yen appreciated as markets became more convinced that the Federal Reserve would cut rates in September and the BoJ's stance grew more hawkish. This appreciation was also driven by FX intervention and the unwinding of yen carry trade positions. After hitting JPY161/USD in early July, the yen strengthened towards JPY150/USD by the end of the month and has now continued its trajectory.

Our previous analysis highlighted that the primary driver of the dollar-yen exchange rate was the unresolved cost-of-carry condition, which persisted until there was a change in the monetary policy outlook from the Fed and the BoJ. Positioning had largely remained underweight on the yen. However, as investors unwind their positions, sentiment has improved, leading to significant bullish yen price action.

The dollar-yen exchange rate is primarily influenced by the cost-of-carry issue, which hinges on the key interest rate decisions of the Fed and the BoJ. Our argument was that if the Fed started to ease and the BoJ continued to normalise rates, the narrowing yield differential would lead to a reversal in the USD/JPY pair. This is exactly what has happened. Also, while extended positioning and valuations suggested a pullback for the USD/JPY exchange rate, timing such a move was challenging due to the uncertainty surrounding the Fed’s and BoJ’s policy rate decisions. 

In conclusion, the financial turbulence in Japan, marked by the yen's rebound and the bear market in Japanese stocks, was driven by key monetary policy decisions from the BoJ and anticipated actions by the Federal Reserve. While the yen's appreciation was foreseen, the sharp sell-off in Japanese equities highlighted the unpredictability of the market. Looking ahead, we expect the USD/JPY exchange rate to balance between 140 and 150.

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