August Meltdown What Triggered It, Why the Rebound and What’s Next?
On July 31st, the Bank of Japan raised interest rates, leading to a sharp decline in the Japanese stock market, which fell more than 11,000 points from its all-time high. This triggered a three-day global sell-off, with the Nikkei 225 plunging 20% and the Nasdaq losing 16%.
In the wake of the stock rout, the Bank of Japan shifted from a hawkish stance to a strongly dovish signal. The Deputy Governor then stated that the BOJ would not raise rates, quoting: 'The bank will not raise its policy interest rate when financial and capital markets are unstable.' This eased market tensions, and global markets began bouncing back.
Source: TradingView
Japan’s underlying issue with a weakening yen
The Japanese economy has struggled with stagnation and slow growth since the early 1990s, a period often referred to as the "Lost Decade." The yen's accelerated depreciation after the pandemic pushed Japan's inflation rate to 4.3% in January 2023, marking one of the highest levels in over 40 years. While the country has been targeting 2% inflation to stimulate growth, this sharp increase was far from the intended outcome. Although inflation has since eased to 2.8%, concerns remain that it could continue on an upward trajectory if the yen's weakness persists.
Source: TradingView
Why Bank of Japan’s decision is crucial for the rest?
When the Bank of Japan lowered its interest rate to -0.1% in 2016, it created an opportunity for investors to engage in the yen carry trade. This involves borrowing Japanese yen at a low-interest rate, converting it into a higher-yielding currency, and, in some cases, investing in equities. As shown in the chart below, this move sparked significant growth in various equity markets. However, the carry trade opportunity seems to have come to an end as the Bank of Japan increased its interest rates twice this year.
Source: TradingView
Market Outlook:
With the Bank of Japan reversing its signal from hawkish to dovish, buying opportunities during market dips in equities remain. However, I will continue to monitor developments in the Japanese yen and its inflation closely. If the yen weakens and inflation rises, the Bank of Japan may resume its hawkish stance once again. Learn more: video.
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