Japanese stocks falter amid yen volatility

Japanese equities had been on a two-day winning streak, but on Thursday, the Nikkei 225 dropped 0.7%, reflecting a growing unease among investors. Concurrently, the yen appreciated 0.6% against the US dollar to 146, reversing the 2% loss it incurred earlier in the week.

The Japanese benchmark index had previously rallied, rebounding from a dramatic decline on Monday, buoyed by reassurances from central bank officials. However, the optimism was short-lived as the downturn extended to European markets, with the Stoxx Europe 600 Index falling 1% by early morning ET. Germany’s DAX and France’s CAC 40 dipped 0.8% and 1%, respectively, while London’s FTSE 100 dropped 1.1%.

US futures indicated a similar bearish sentiment, with S&P 500 futures down 0.5% and Nasdaq futures declining 0.4%.

Bank of Japan hawkish

On Wednesday, Bank of Japan (BOJ) deputy governor Shinichi Uchida attempted to soothe market nerves, stating that the central bank would avoid raising interest rates during periods of financial instability. This followed Monday’s market chaos, driven by heightened expectations of a continued tightening in Japan’s monetary policy.

The yen's surge, triggered by the BOJ’s recent hawkish signals, forced many investors to unwind carry trades—borrowing cheaply in yen to invest in higher-yielding assets elsewhere—intensifying global market declines.

Uchida expressed confidence in a soft landing for the US economy, despite growing fears that the Federal Reserve might be lagging in its rate-cutting measures. Nevertheless, these concerns, coupled with the yen’s volatility, continue to haunt the market.

Stephen Innes, managing partner of SPI Asset Management, highlighted the potential impact of a broader US economic slowdown, misaligned global monetary policies, and rising geopolitical tensions in the Middle East on financial markets. He noted that yen volatility remains a significant factor in the current market turbulence.

Monday’s drastic 1987-like drop in the Nikkei sparked a global market sell-off. Despite the BOJ's deputy governor downplaying the likelihood of an imminent policy hike, his comments were not intended to signal a reversal in monetary policy, according to Alex Kuptsikevich, senior market analyst at FxPro.

Japan has maintained inflation near the BOJ’s 2% target for almost two years, allowing the end of zero interest rates. Meanwhile, the Federal Reserve faces challenges with slowing inflation and a cooling labor market, and a rate cut is anticipated in September.

The narrowing interest rate differentials, which have supported the yen carry trade, could push the yen higher. UBS's chief Japan economist Masamichi Adachi suggested that a US recession and aggressive Fed easing could see the dollar fall to 120 yen or lower.

Conclusion

Looking ahead, the global trading environment remains fraught with uncertainty. Stephen Innes warned that the upcoming US political election could further destabilize markets, transforming them from a "chaotic mosh pit" rather than a "graceful waltz."

UBS Chief Investment Office analysts advised against making significant portfolio changes based on the election's uncertain outcome, with only three months until Election Day.

In other Asian markets, South Korea’s Kospi ended 0.5% lower, halting a two-day rally, while Taiwan’s Taiex dropped 2%. Hong Kong’s Hang Seng remained flat in its latest trading session.