IN LESS than a week, Japan has completely upended the world’s expectations for its markets and economy.
The country was the darling of the financial world for over a year. Its weak currency pushed the stock market to record highs and rekindled inflation after decades. Then the Bank of Japan (BOJ) hiked rates last Wednesday (Jul 31) and governor Kazuo Ueda indicated he intended to keep going, helping trigger a sharp rise in the yen and wild gyrations across the global markets. Traders and investors were forced to abandon strategies based on macro views that Japan’s currency would stay weak and interest rates would not rise too fast.
“Without a doubt, this is absolutely new ground for markets. There’s soul searching everywhere now that we have a BOJ that seems hellbent on getting away from years of zero or negative rates policy,” said Stephen Miller, a consultant at Grant Samuel Funds Management and former BlackRock fund manager. “Japan is now at the centre of emergent worries – across everything, stocks, bonds, yen, credit, everything.”
Volatility coursed through Japan’s markets with the Nikkei 225 suffering its biggest rout since 1987 on Monday, only to come roaring back 10 per cent the next day. The whiplash carries implications for the country’s politics and households as the market turmoil could impact consumer confidence and Japan’s delicate climb out of deflation. Adding to investors’ confusion, the yen weakened about 2 per cent on Wednesday after BOJ deputy governor Shinichi Uchida said the bank would not raise rates as long as markets are unstable.
“The risk is that consumption and investment will be held back due to the increased uncertainty in the markets,” said Hirofumi Suzuki, chief foreign exchange strategist at Sumitomo Mitsui Banking. “If it drags on, it could affect business behaviour and households as well.”
The initial historic sell-off in the market indicates that any momentum trades hoping to profit from the weak yen and the broad rally in Japanese equities have been wiped out, according to analysts. The surge in the yen also derailed one of the most profitable market strategies this year: carry trades which involve borrowing the Japanese currency to invest in other global assets. The yen’s rebound set off a rush to take profits on these trades and close positions, which exacerbated the currency’s rise.
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“This outsized response compared with previous instances of carry trades being quickly unwound suggests there is more at play in Japan than recession fears – and could have global ramifications if it continues,” said Wei Li, global chief investment strategist at BlackRock.
Politicians and business leaders have sought to soothe concerns in Japan, particularly around expanded tax-free investment accounts – an initiative to get people to move some of the more than one quadrillion yen sitting in bank accounts as at March into the market. Foreign investors that have stayed will likely be taking a longer view focused on companies that have been diligent about reform, business growth and balance sheet management.
“I think it’s a market that should now suit fundamental analysis – bottom up, rather than top-down,” said Pelham Smithers, whose London-based firm offers research on Asian companies with a focus on Japan. “Going forward it becomes an interesting time if you are a stock picker.”
There’s an emerging view that BOJ’s move was a misstep and influenced by political pressure, as several prominent politicians had called out the weak yen in recent weeks. That could jeopardise the relationship between the Japanese government and the central bank – and impact Prime Minister Fumio Kishida’s bid to be reelected as the head of Japan’s ruling party next month, said Takuji Aida, chief economist at Credit Agricole.
Others supported the BOJ’s move. Christopher Willcox, the head of trading and investment banking at Nomura Holdings said the increase in rates was the right decision given the country’s macro environment and changing decades of easy money policy was bound to be disruptive.
“They always knew that the unwind was going to be very difficult,” said Willcox. “So I think the BOJ is playing it extremely smart.”
A downturn in the market could also spark an increase in stock buybacks as companies take advantage of lower share prices. Regulators and overseas investors have been pushing for firms to adopt a more shareholder friendly policies.
“This opportunity is unique,” said Atul Goyal, an equity analyst at Jefferies. “The sell-off creates an opportune moment as some companies are about to announce results and have board meetings, it’s possible for some of them to announce large buybacks.”
As they look for opportunities in the new environment created by the BOJ and the resulting market turmoil, there is a broad consensus that investors will have to reevaluate what they thought they knew about the country.
“The only playbook is to discard the playbook you have had for decades,” Miller said. BLOOMBERG
