Japanese Stocks' Volatility: Can Economy Bear Rising Rates?
The Japanese government introduced a new small-scale investment tax exemption system (NISA) at the beginning of this year, aiming to encourage citizens to convert savings into investments. Under this system, investors opening a securities account through NISA can enjoy a tax-free allowance on investments up to a certain limit every year. However, just three days prior to this announcement, many first-time investors in the Japanese stock market, buoyed by the NISA scheme, faced severe losses during an unprecedented market volatility event.
This tumultuous period reached its zenith on August 5. On that day, the Tokyo Stock Exchange index futures and Nikkei 225 index futures both experienced two circuit breakers. By the end of the trading day, the Nikkei 225 index had plummeted by 12.4%, erasing all the gains for the year. The Tokyo Stock Exchange index fell by 12.23%. This marked the most significant single-day decline for the Nikkei 225 index since October 1987, with the number of points lost in a single day hitting an all-time high.
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In a dramatic twist, just one day later on August 6, the Nikkei index saw a remarkable turnaround, surging more than 3,200 points at one point, surpassing the previous high of 2,677.54 points from October 1990. Numerous investors, catching their breath, lamented online about having sold too early.
As the Japanese stock market plummeted, the yen also faced pressures, declining over 1% against the dollar on the same day, halting the five-day streak of yen appreciation that followed the Bank of Japan's interest rate hike the previous week. On August 5, the yen had briefly touched a new high of 144.77 against the dollar, its strongest level since January. As of August 6, the exchange rate stood at 145.19.
According to Professor Chen Zilei, director of the Japanese Economy Research Center at Shanghai University of International Business and Economics, the market's reactions were overly intense, reflecting a lack of confidence in the Bank of Japan's policies. "The outflow of capital was driven by panic, stemming from doubts about Japan’s economy and central bank policies. The opacity of the Federal Reserve's actions added to the uncertainty, prompting investors to flee and clear out, resulting in the chaos that triggered the 'butterfly effect' on August 5," he explained. He emphasized that it is crucial to monitor the ongoing financial market turmoil in Japan and the U.S., as many economic crises historically have roots in panic-driven responses.
The Dilemma of Timing an Interest Rate Hike
The plunge in the stock market and the yen's subsequent rise were undoubtedly catalyzed by the Bank of Japan's hawkish stance announced on July 31. On that day, the bank raised its policy interest rate from 0.01% to 0.25%, marking the first return to this level after over 15 years. The bank also unveiled plans to significantly cut its vast bond-buying program, a clear pivot from the extensive stimulus measures that had been in place for a decade. Earlier in March, the Bank of Japan had abandoned its negative interest rate policy.
Japanese public opinion weighed in, suggesting that the timing of the interest rate hike following a dismal employment report from the United States on August 2 contributed to the "Black Monday" effects in the Japanese stock market. One observer even questioned, "Knowing that the U.S. would release troubling employment data, why not wait a bit longer before the hike?"
Regarding the interest rate hike, Professor Chen noted that it wasn't unexpected, and he anticipated some strengthening of the yen. "The challenge lies in the absence of data highlighting the state of corporate operations and the economic effects of wage increases. There are divergent views within the committee, but as the timing of the Federal Reserve's potential rate cuts approaches, the window for a rate hike in Japan becomes critical; missing it could leave policymakers in a reactive position," he elaborated.
In the Bank of Japan's previous policy meetings, the decision to raise rates was made at a thin margin of 7 to 2 votes. Notably, discussions about whether to hike rates continued even four hours before the meeting's start, revealing the pressures and dilemmas faced by the Japanese government in making this decision.
Shigeto Nagai, chief economist at Oxford Economics, echoed this sentiment, commenting that the move took many observers of the Bank of Japan by surprise. "Many had expected the Bank to wait for clearer indicators regarding income and consumption before acting," he explained.
Nagai posited that this unexpected move reflects not only a strong internal desire for normalization of Japan's monetary policy but also highlights the pressing issue of long-term yen depreciation. "Changes in interest rates will affect the future policy direction of the Bank of Japan. Continued weakness of the yen poses risks to the government's goal of fostering a positive feedback loop between wages and inflation," he stated.
Additionally, Sakai Saikei, chief economist at Mizuho Research Institute, suggested that the Bank of Japan might consider further tightening this year, raising interest rates by another 0.25%. "Following the recent hike, we expect to see heightened volatility in the market for a period, followed by a gradual slowing of yen appreciation," he projected.
The Impacts of Yen Appreciation
Professor Chen pointed out that viewed through the lens of the Bank of Japan's actions to curb its balance sheet and raise rates, there remains potential for long-term appreciation of the yen. Furthermore, Japanese companies are likely to increase overseas investments as they seek opportunities abroad. However, factors such as the strength of the dollar, Federal Reserve policies, and global economic conditions will collectively influence the future trajectory of the yen's exchange rate.
In this rapid surging of the yen, who emerges as the biggest winner, and who loses?
Following the market crash, Tanaka Haruna, a consultant at Resona Bank, remarked that the significant drop in the stock market evidently dampened expectations for Japanese exporting companies, leading many to frantically sell dollars out of concern that the yen might further appreciate. Many Japanese firms set their 2024 fiscal year foreign exchange rates at around 155 yen per dollar. This sudden surge in the yen would compel these companies to revise their earnings estimates downward, igniting fears among investors who began to sell off stocks, causing the Nikkei average to experience its most substantial decline of the year.
In recent times, major Japanese trading houses have performed exceptionally well in international markets, largely benefiting from favorable exchange rate differences. The average net profit of listed Japanese companies surged by 24% in the 2023 fiscal year, significantly attributed to profits earned in dollars abroad being converted into yen. Consequently, firms heavily reliant on foreign markets face tough adjustments in both cost management and pricing strategies.
Moreover, the impact of yen appreciation on the booming Japanese tourism sector warrants attention. As reported by the Japan National Tourism Organization (JNTO), the number of visitors to Japan reached a record high of 17.78 million in the first half of the year. If trends continue, this year could potentially see the total number of visitors surpass the record of 31.9 million set in 2019. The World Travel and Tourism Council (WTTC) predicts that 2024 will be a record-breaking year for Japan's tourism sector, with the contribution of tourism to the economy expected to reach nearly 44.6 trillion yen, representing a 5.7% increase from the peak in 2019, accounting for 7.5% of Japan's GDP.
With the yen strengthening, the cost of travel for foreign tourists to Japan is likely to increase, which may influence their spending behavior and overall tourist activity, increasing uncertainty for the Japanese tourism industry. Among the businesses that saw significant drops in stock prices on August 5, Isetan Mitsukoshi Holdings, which has a considerable share of duty-free sales, ranked third with a staggering 46% decline.
In the past, a weaker yen led to higher costs for imported goods such as oil, gas, and agricultural products, which subsequently translated into rising prices for consumers. Many locals expressed on social media their hopes for yen appreciation amid concerns about high prices. However, doubts remain about whether past price rises would revert to previous levels, with citizens questioning the effectiveness and permanence of the potential price reductions following yen appreciation. "When the yen weakens, prices for electricity and gasoline tend to rise easily, yet even with a stronger yen, prices might only drop to misleading levels," some users remarked.
During a press conference on July 31, the Bank of Japan's governor, Kazuo Ueda, showcased a hawkish tone while still expressing concern over whether the Japanese economy could withstand rising interest rates.