Why Japanese stocks are on a rollercoaster ride

As fears of an American recession spread, stockmarkets around the world have been jittery. The moves have been the wildest of all in Japan. On August 5th the Topix plunged by 12% in its worst performance since 1987; the yen had climbed from its weakest point in 37 years. The next day, stocks swung back, rising by 9%, as investors snapped up stocks that had plunged in value. The sharp moves carry implications not just for Japanese investors and firms. The country’s financial heft means that they could become a source of further volatility in nervous global markets.

Topsy-turvy markets reflect changes in monetary policy. Over the past 18 months the yen sank as America’s Federal Reserve raised interest rates and the Bank of Japan stood still. The “carry trade”, where investors borrow cheaply in yen to make higher-yielding investments in dollars or euros, flourished, sending the Japanese currency lower still. The weaker currency then enhanced the foreign earnings of Japanese firms, and enticed foreign investors into the Japanese stockmarket. In 2023 and the first half of 2024, they snapped up ¥9trn ($60bn) in stocks.

Then interest rates began to shift. On July 31st the Bank of Japan raised its benchmark rate from around 0.1% to around 0.25%. By contrast, investors expect the Fed to begin cutting rates soon. Anticipation grew on August 2nd after the release of America’s jobs report, which showed the economy had added 114,000 jobs in July, below the 175,000 expected by investors.

A modest move in rate differences was amplified by a rapid turnaround in speculative bets. Investors had crowded into short yen trades—bets on a further depreciation in the Japanese currency—according to data from the American Commodity Futures Trading Commission. Such one-way traffic can cause sudden shifts in the other direction, as speculators abandon their trades and cover their losses, bidding up the yen in the process.

The spiking yen, in turn, fuelled the stockmarket slump. Japan’s exporters suffered the most: they lose almost mechanically from a stronger currency, as they make most of their money overseas but report earnings in yen. Margin bets on Japanese stocks—trades made with borrowed money—had reached the highest level since 2006 before the sell-off began. Those leveraged investments were unwound at pace.

Traders piled back in on August 6th, judging that the sell-off had been driven in large part by forced selling by debt-laden investors. The darlings of the earlier rally have seen the greatest swings. The share price of Tokyo Electron, a vital supplier of semiconductor kit, fell by 18% on August 5th and rose by 19% the next day. Japanese banks, which had plunged by 27% in the space of two trading days, made a modest recovery of 3.5%.

Few analysts think the gyrations mean that Japanese firms are in deep distress, or fear for the stability of the country’s financial system. Nonetheless, rapid changes in Japan can have knock-on consequences. As interest-rate moves make the carry trade less viable, they could fuel a sell-off in far-flung corners of foreign markets. Japan is also the largest creditor in the world. The country’s investors owned $10.6trn in foreign assets at the end of last year. They have become big buyers of American and Australian collateralised-loan obligations, for instance. If the stronger yen means these investors need to dump foreign holdings to meet liabilities at home, that could weaken asset prices while driving the yen still higher. Precisely how much market turmoil is left to come in Tokyo remains unclear. Until speculative and heavily leveraged bets have fully unravelled, though, expect choppy conditions. ■

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