"Situation Reversed" Japan, Once Loved by Global Investors, Now a Source of Concern

Japan, which has been favored by global investors, has become the center of concern in just one week. It is diagnosed that worries have arisen across all sectors including stocks, bonds, yen, and credit.

[Image source=AFP Yonhap News]

Bloomberg reported on the 7th (local time) that "it took less than a week for Japan to completely overturn global expectations for its market and economy."

Previously, the Tokyo Stock Exchange and the yen exchange rate, which had been rallying after hitting record highs, have recently experienced a rollercoaster ride. Just a week ago, the Bank of Japan's (BOJ) interest rate hike led to the unwinding of yen carry trades, fueling a global stock market crash, not only in Japan but worldwide. Additionally, Governor Kazuo Ueda’s hint at a possible further rate hike on the day of the meeting shook the currency market. For investors, this meant abandoning all strategies based on the macro view that the yen’s weakness would continue and that sharp rate hikes would not occur.

Stephan Miller, a Grand Samuel Fund consultant and former BlackRock employee, said, "Undoubtedly, this is an absolutely new territory for the market," adding, "As the BOJ struggles to move away from years of zero or negative interest rate policies, revaluations are happening everywhere." He assessed, "Now Japan has become the new center of concern across everything including stocks, bonds, yen, and credit."

Volatility in the Japanese market has recently surged sharply. The representative stock index, the Nikkei 225 average, recorded its largest drop since 1987 on the 5th, amid growing recession fears triggered by a U.S. employment shock. The following day, it surged 10% again due to a rebound buying from the previous day’s excessive decline.

Such increased volatility is expected to affect not only Japan’s goal of escaping deflation but also overall consumer confidence, with repercussions on politics and households. After Deputy Governor Shinichi Uchida of the BOJ stated that there would be no rate hike while the market remains unstable, the yen weakened again by over 2%, which is also a headache for investors.

Hirofumi Suzuki, Chief Foreign Exchange Strategist at Sumitomo Mitsui Banking Corporation, pointed out, "The risk is that increased market uncertainty could suppress consumption and investment," adding, "If this situation continues, it could impact companies and households." Earlier, the sharp rise in the yen led to a rapid unwinding of yen carry trades. Bloomberg noted this means that momentum trades based on yen weakness and the Tokyo stock rally have all disappeared.

Wei Li, Global Chief Investment Strategist at BlackRock, evaluated the speed of the recent yen carry trade unwinding as an overreaction compared to the past, suggesting "there may be factors at play beyond just fears of a recession in Japan." He predicted, "If this situation continues, it could affect the entire world."

Currently in Japan, criticism is mounting that last week’s BOJ rate hike was a mistake, and there are suspicions that the decision was influenced by political pressure. Bloomberg predicted that this situation could jeopardize the relationship between the Japanese government and the central bank. It is also expected to make it difficult for Prime Minister Fumio Kishida to declare a re-election bid ahead of the Liberal Democratic Party leadership election in September. Kishida, who has recorded a support rate low enough to be considered near resignation, has not yet clearly stated whether he will run.

However, some voices support the BOJ’s move. Christopher Wilcox, Head of Trading and Investment Banking at Nomura Holdings, diagnosed that considering the macro environment, the rate hike was the right decision, and that the change from decades of monetary easing policies is inevitably disruptive. There are also suggestions to reassess Japan’s investment environment and seek opportunities amid the recent market turmoil. Consultant Miller said, "The only strategy is to abandon the strategy you have used for decades."