Storms Return to the Asia-Pacific Markets!

Although the U.S. stock market closed with a strong performance last Friday evening, the Japanese stock market did not receive a boost this morning. The Nikkei 225 index fell directly after a slight opening low, once dropping by 1.4%. At the same time, the yen has risen to near 143.

So, why is the Japanese stock market falling at this time? Will the yen carry trade impact the market again? Analysts believe that there are three main reasons for the morning sell-off in the Japanese stock market:

Firstly, interest rate expectations. Bank of Japan Governor Haruhiko Kuroda stated at a hearing in the Japanese Diet that the basic stance of the Bank of Japan has not changed, and if it is confirmed that the economy and inflation development are in line with expectations, the Bank of Japan will continue to raise interest rates. The International Monetary Fund indicated that there is still room for the Bank of Japan to raise interest rates.

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Secondly, the surge in the yen. After the Federal Reserve released a clear interest rate cut expectation, the U.S. dollar began to plummet significantly, with the U.S. dollar index breaking below 101, while the yen has risen to near 143, just a step away from the exchange rate level when the yen carry trade reverses.

Thirdly, there are internal structural issues in the Japanese stock market. This morning, Nissan's decline expanded to 5.5%, following Morgan Chase's downgrade of its rating to underweight.

Unexpected in the Japanese Market

Last Friday, Federal Reserve Chairman Powell stated at the Jackson Hole Annual Meeting that the time for policy adjustment has come. Immediately, the capital market underwent a major change. The U.S. stock market made a significant counterattack, the U.S. dollar plummeted significantly, and the swap market expected nearly 100 basis points of interest rate cuts by the Federal Reserve before the end of the year. The inversion of the U.S. 2-year and 10-year Treasury yield curve narrowed.

This situation should correspond to a collective surge in the Asia-Pacific market this morning, but this is not the case. This morning, the Japanese stock market opened slightly low and then continued to adjust downward, with the Nikkei 225 index's decline once expanding to 1.4%.

At the same time, the U.S. dollar against the yen continued to fall, once dropping by 0.61% to 143.49, and then fluctuated at a low level. It is worth noting that this morning, apart from the yen, the overall performance of the Asia-Pacific currencies was stable, and there was no significant increase as imagined. The surge in the yen is likely still related to the significant drop in the U.S. dollar. Last Friday, the U.S. dollar index fell by 0.82%, and the index has already broken the key level of 101.Additionally, South Korea's stock market did not show a significant sell-off in the morning session. So, what exactly accounts for the Japanese stock market's such trend?

Analysts believe that, according to a report by J.P. Morgan analysts, trend-following hedge funds have reversed their bearish views on Japanese equities and began buying late in the previous week. Hedge funds employing the Commodity Trading Advisor (CTA) strategy may have resumed their positions in the Nikkei 225 futures and the Topix futures around August 15th. Previously, J.P. Morgan's global quantitative and derivatives strategist, Masanari Takada, stated that by August 9th, CTAs had sold approximately 50% of their Nikkei futures long positions. This is one of the main reasons for the sharp decline in Japanese stocks. With the yen appreciating again and rising close to the high levels during the crash, CTAs may be selling once more.

Apart from that, there are also internal structural issues within the Japanese stock market. Previously, J.P. Morgan downgraded Nissan Motor's rating from "neutral" to "underweight," and the target price was reduced from 560 yen to 330 yen. Analysts said the downgrade was due to the company's weak business in the United States and the decline in profit risks over the next few years. In today's morning session, Nissan's share price fell by 5.5%.

Japanese Interest Rate Direction

Recently, there has been a view that Japan may not raise interest rates again this year. However, the current expectations remain vague.

On August 23rd, at a hearing in the Japanese Diet, Kazuo Iwata stated that the Bank of Japan's basic stance has not changed, and if they are confident that economic and inflation developments are in line with expectations, the Bank of Japan will continue to raise interest rates. "Japan's short-term interest rates are still very low, and if the economic situation is good, interest rates will be raised to what we consider a neutral level," Iwata said at the hearing, indicating that there is still considerable uncertainty about the ultimate level of Japanese interest rates. However, he also stated that the Bank of Japan will closely monitor the impact of unstable financial markets on inflation and is not in a hurry to push for the next rate hike.

On the other hand, the International Monetary Fund (IMF) has indicated that the Bank of Japan still has room to raise interest rates. They can gradually increase rates because the strengthening of inflation expectations has left further room for the normalization of its ultra-loose monetary policy. The pace of further interest rate hikes in Japan will be "very data-dependent," and the Bank of Japan will pay attention to the speed of wage growth and the rise in inflation expectations during the policy normalization process. Last Friday, IMF Chief Economist Pierre-Olivier Gourinchas stated, "We expect that with inflation expectations remaining stable near the new level of 2%, the Bank of Japan will begin to normalize policy interest rates."

But in any case, a cut in U.S. interest rates in September is essentially certain. Under this premise, the yen's carry trade function may gradually be replaced by the U.S. dollar. Previously, some international banks also held this view. Additionally, there are certain opportunities for equity markets. The modest adjustments in the Japanese stock market may not affect the overall situation.

CICC believes that 2019 is a more comparable benchmark scenario. During the rate cut cycle in 2019, after the first rate cut, long-term U.S. Treasury yields bottomed out, gold peaked, copper and U.S. stocks gradually rebounded, rather than waiting for the end of the rate cut cycle. This time may also be similar; the denominator assets are the main trading opportunities before the rate cut, with the greatest elasticity, and recent performance has fully proven this point. However, due to the full incorporation of expectations and the limited extent of the rate cut, when the rate cut is realized, it may also be time to gradually take profits and retreat, rather than aggressively adding positions. On the contrary, those molecular assets that benefit from the rate cut stimulus can be moderately added at the right time, and the recent gradual rebound of copper and the gradual recovery of U.S. real estate data are typical examples.