From falling below the 154 level last Tuesday to briefly breaking through the 143 level today, the US dollar has plummeted by over 1000 points against the Japanese yen in just five trading days.
The significant appreciation of the Japanese yen and the lifting of global forex arbitrage trading around it seem to have become an unavoidable topic for many institutional analysts studying the recent global stock market crash, especially for traders in the Japanese market.
In fact, if you want to be a good stock trader right now, you may first have to become an excellent forex analyst
It all starts with the skyrocketing Japanese yen
Market data shows that in the past month, the exchange rate of the Japanese yen against the US dollar has risen by more than 10%, which is in sharp contrast to the situation before the US Independence Day holiday on July 4th, when the exchange rate of the Japanese yen against the US dollar fell to 161.96 yen for the first time since December 1986.
It is not difficult to see that since last Thursday, when the global stock market decline has rapidly intensified, it is also the time when the US dollar is accelerating its decline against the Japanese yen.
The reason behind the rise of the Japanese yen is obviously not difficult for people to find: the interest rate spread between the United States and Japan is expected to narrow. At last week's interest rate meeting, the Bank of Japan aggressively implemented a tightening policy combination of "rate hikes+QT", raising the short-term policy rate from 0-0.1% to 0.25% and announcing a phased reduction of the monthly asset purchase plan from 6 trillion yen to 3 trillion yen next year.
Meanwhile, following the Federal Reserve's signal last week to cut interest rates in September and the subsequent release of multiple sets of unusually dismal US economic data, bond traders are betting that the US economy is on the brink of deterioration and that the Fed will need to begin a significant easing of monetary policy to avoid an economic recession.
After last Friday's non farm payroll, traders in the interest rate futures market priced the rate cut before the end of this year at around 125 basis points - equivalent to five 25 basis point rate cuts. This indicates that if the Federal Reserve did not urgently cut interest rates outside of regular meetings, it is likely to cut 50 basis points in one go in the last three meetings at the end of the year.
The opposite policy direction of loose and tight monetary policies between the United States and Japan has directly driven the yen to rise like a wild horse.
As the most common financing currency in the world, the retaliatory appreciation of the Japanese yen in a short period of time has undoubtedly damaged the performance of arbitrage trading, which is quite common in the global market. This type of transaction typically involves traders borrowing in currencies with lower interest rates and investing in high-yield assets - borrowing in Japanese yen is almost free when interest rates remain at their lowest levels for a long time.
Alvin Tan, head of Asian currency strategy at Royal Bank of Canada in Singapore, said that traders are increasingly concerned about the risk of a US economic recession after the latest data shows that the US unemployment rate has risen to 4.3%. This is a bad environment for interest rate traders.
The risk of economic recession also means increased market volatility, so arbitrage trading will be reduced. I think this situation is easy to continue because we have been in a low volatility environment for a long time, in fact, more than a year, "Tan said.
Why is the scope of influence so vast?
For many traders, if they had previously financed with cheap yen and invested in high-yield markets to gain high returns, they would now have to simultaneously lose the decline in high-yield assets (such as US stocks) and the rise in the yen exchange rate (which needs to be repaid at the end of the trade). This astonishing reversal has triggered a global arbitrage trading frenzy.
In late last month, we had a preliminary introduction to the relationship between the sharp rise of the yen and the sharp decline of technology stocks. However, the current situation seems to be even more serious than at that time.
In a research report released over the weekend, China International Capital Corporation (CICC) pointed out that the prerequisite for carry trades is the inability to implement exchange rate hedging. Therefore, when the yuan appreciates on the same day, the profits obtained from the interest rate spread will be quickly consumed by the losses caused by the exchange rate. Therefore, it is necessary to close positions by "selling high-yield assets and buying back yen". Closing positions will also bring further pressure on the appreciation of the yen, which in turn will lead to more yen liquidation, and so on.
Peter Schiff, Chief Market Strategist of Europe Pacific Asset Management, also wrote over the weekend that the opportunity for investors to borrow almost for free has ended, and they have begun to liquidate arbitrage trades around the yen, which has led to increased volatility in foreign exchange and other markets.
Peter Schiff pointed out that there are many potential impacts on the global market. The fluctuation of the Japanese yen may cause trouble for leveraged bets, potentially triggering a wave of margin calls and triggering a broader global sell-off. If the appreciation of the yen leads to an increase in prices of commodities such as oil, prompting the Bank of Japan to take more intervention measures and further eliminate arbitrage trading, this risk will further intensify - Schiff believes that this situation may evolve into chaos in the global market.
Schiff said that for a long time, yen arbitrage trading has supported the global bull market because it allows cheap loans to be invested elsewhere. Now, the lifting of yen arbitrage trading may lead to turbulence in stock markets outside of Japan. The Bank of Japan is in a dilemma: should it protect the yen, stabilize the stock market, or rescue government bonds (which the Bank of Japan holds about half of)? In the case of what Schiff called the tail snake of currency and economy, the Bank of Japan has no simple solution.
Coincidentally, Nick Twidale, Chief Market Analyst at ATFX Global Markets, also stated that there has been a large-scale surrender of arbitrage trading positions, with "everyone running towards the door at the same time. These actions were initially triggered by the Bank of Japan's interest rate hike, but in the past few days, concerns about global economic growth have also been fueling the fire, and selling has become intense
Why are Japanese stocks so miserable?
Throughout recent global markets, it is not difficult to observe that Japanese stocks have experienced the most dismal decline in the global market - the Nikkei 225 index closed down 12.4% on Monday at 31506 points, wiping out all gains since the beginning of the year. This is the largest point drop in the history of the Nikkei 225 index, surpassing the record set on Black Monday in October 1987.
So, is there a direct correlation between the sharp decline in Japanese stocks and the foreign exchange market? The answer is displayed as: YES.
In fact, even setting aside the severe impact of the appreciation of the yen on the profits of Japanese exporters, in terms of funds, some of the funds borrowed through cheap yen in the past will be directly invested in the Japanese market, rather than seeking arbitrage in overseas markets. Especially in the context of the continuous rise of the Japanese stock market in recent years, investing in the Japanese market nearby has become a profitable transaction.
The most well-known story in the past few years is undoubtedly the story of "stock god" Buffett issuing Japanese bonds to invest in Japanese trading companies.
However, now these overseas investors may also be playing the drums of withdrawal. According to data released by the Japan Stock Exchange Group, foreign investors have sold a net of 1.56 trillion yen (approximately 10.7 billion US dollars) worth of Japanese cash stocks and futures in the week ending July 26. The Tokyo Stock Exchange Index fell more than 5% during this period, the largest decline in four years. Previously, foreign investors were the main driving force behind the rise of Japanese stocks.
Mizuho Securities' senior technical analyst, Feng Miura, pointed out that "investors are selling stocks that were previously expected to have higher performance due to the depreciation of the yen. The Japanese stock market was heavily bought due to the depreciation of the yen, and this prerequisite is crumbling
Zahir Kahn, a senior fund manager at Swiss investment firm UBP Investments, believes that "currently, the volatility of Japan's foreign exchange and stock markets is too high, and long-term overseas investors will not enter temporarily. Even if those lagging behind hope to enter, they will need to wait for market stability. We have not yet heard any buying or selling news from peers
Interestingly, in the eyes of some market participants, the largest arbitrage trader in the current financial market is actually the Japanese government itself.
For a long time, the Japanese government has been "financing" itself with the extremely low real interest rates imposed by the Bank of Japan on domestic depositors, while obtaining higher returns from longer-term domestic and foreign assets. With the widening gap in returns, this has created additional fiscal space for the Japanese government. It is crucial that one-third of these funds are actually overnight cash: if the central bank raises interest rates, the government will have to start paying funds to all banks, and the profitability of arbitrage trading will soon begin to weaken.
The well-known financial blog website Zerohedge pointed out that this time, with the collapse of arbitrage trading, the Bank of Japan will either do nothing and watch the economy collapse, or panic and reverse last week's interest rate hike and increase loose policy efforts to curb the collapse that just pushed the Nikkei 225 index into a bear market. However, in either case, unfortunately, the Japanese market seems to be doomed.