Japanese stocks plunge 6%, forced unwinding of carry trades, yen continues to appreciate

Black Friday continues to ferment, with the Japanese stock market facing a significant correction after hitting a historical high in July. The Nikkei 225 index opened on Monday with a drop of over 6%, with Mitsubishi, Mitsui, Sumitomo, and Marubeni all plummeting by more than 10%. The Japanese yen also continues to strengthen, with the USD/JPY falling from 153 since the Bank of Japan announced a rate hike last Wednesday, currently trading at 145.49, appreciating nearly 5%.

Japanese Stocks Hit Eight-Month Low

After the Bank of Japan raised its benchmark interest rate to the highest level since 2008, the Japanese stock market has fallen for three consecutive days, hitting an eight-month low.

With the Bank of Japan's hawkish move to raise interest rates to 0.25%, is the era of a cheap yen officially over?

Bruce Kirk, Chief Japanese Stock Strategist at Goldman Sachs, said in an interview with CNBC that the rebound in the Japanese market has entered a "transitional phase." He explained that the past two years of rebound in Japan were driven by three factors: a weak yen benefiting blue-chip exporters and banks, expectations of monetary policy normalization, and corporate governance reforms.

However, the rules of the game are changing, especially in terms of interest rates and foreign exchange. Investors are reevaluating industry positioning in the market. Due to various factors, including higher exposure of Japanese small and medium-sized enterprises to domestic demand and reduced vulnerability to exchange rate fluctuations, investors are showing interest in Japanese small and medium-sized enterprises for the first time in three years.

Yen Continues to Strengthen, Forced Closure of Interest Rate Carry Trades

Since the Bank of Japan announced the rate hike, the USD/JPY has dropped from 153 to the current level of 145.49, with the yen appreciating by nearly 5%.

Investors are assessing whether the Japanese economy can withstand a rate hike of this magnitude and whether Japanese export companies can make money with a stronger yen.

On the other hand, the yen, which serves as a long-term interest rate carry trade tool, has also been affected by the recent market plunge, forcing investors to close positions. This has led to a significant appreciation of the yen. If the market continues to decline in the short term, it will trigger more domino effects.

Note: The interest rate carry trade refers to borrowing money in a low-interest-rate country like Japan and exchanging it for the currency of a higher-interest-rate country like the United States to earn the interest rate differential.