The BOJ's pivot has rattled markets badly, with Japanese stocks tumbling for a second day on Friday, adding to a global sell-off following weak U.S. economic data and tech earnings.

The Nikkei 225 fell more than 5.5% as the yen neared its highest level since March, weighing on Japan's export-oriented economy. The 10% plunge in the Nikkei Bank Index put an exclamation point on a bad day for the Japanese stock market. With less than an hour to go, the Japanese stock market is heading for its worst trading day since October 2008.

Not only Japan, but also the entire Asian stock market, from South Korea to Hong Kong, fell on Friday, with artificial intelligence chip maker SK Hynix Inc. plummeting 8.7%. The three major A-share indices fell further in the afternoon, with the Shenzhen Component Index falling by 1%, the ChiNext Index falling by 1.3%, and the Shanghai Composite Index falling by 0.6%. Hong Kong stocks fell further in the afternoon, with the Hang Seng Technology Index falling by more than 3% and the Hang Seng Index falling by about 2.3%. South Korea's KOSPI index fell by 4% in late trading.

The MSCI Asia Pacific Index fell as much as 3.1%, the biggest drop in more than two years, with technology and industrial companies leading the decline. S&P 500 and Nasdaq 100 futures also fell in Asian trading, exacerbating the declines in the relevant benchmarks on Thursday. Meanwhile, U.S. Treasuries rose again, with the 10-year Treasury yield falling below 4%, partly reflecting stronger demand for safe-haven assets.

Foreign investors sell most Japanese stocks since September

What is unnerving Japanese investors is the prospect of further rate hikes by the Bank of Japan, which would strengthen the yen further. The Bank of Japan's major policy shift this week makes another rate hike in October very likely and increases the likelihood of quarterly rate hikes, according to a former executive director in charge of monetary policy.

"The recent strength of the yen, coupled with weakness in the tech sector, will have a big impact on Asian equities," said Manish Bhargava, a fund manager at Straits Investment Holdings in Singapore. "Japanese exporters are particularly vulnerable to a stronger yen, which erodes the value of their overseas earnings." Just three weeks ago, Japanese stocks had climbed to new records as financial stocks cheered the prospect of a rate hike by the Bank of Japan. But now, investors are taking profits on financial stocks, which had been the best performers on the Topix index as investors had thought they should benefit from higher interest rates.

The biggest concern for stocks is the yen, which hit 148.51 per dollar on Thursday, its highest since mid-March. Strategists at Amundi and TD Securities think the yen could rise to 140. "In short, it's mainly the yen," said Kyle Rodda, senior market analyst at Capital.Com. "The market is deepening bets on U.S. rate cuts because of concerns about slowing economic activity at a time when the Bank of Japan has just started to tighten policy settings."

In addition to the recent surge in the yen, concerns about the health of the world's largest economy have also weighed on stocks. "I didn't expect the stock market to fall so much," said Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Asset Management. "It's probably because people are worried about a widespread collapse of the U.S. economy, which is the most unpleasant mode for Japanese stocks." The firm said it may be temporary, but Japanese stocks are in the worst shape.

“Foreign investors appear to be selling stocks as the outlook for corporate earnings is changing amid concerns about a slowing U.S. economy and a stronger yen,” said Ryuta Otsuka, a strategist at Toyo Securities Co., Ltd. “The market has clearly turned bearish in the short term, and the medium-term trend of Japanese stocks may begin to change due to concerns about the U.S. economy.”

Economists expect job growth to slow in the July U.S. nonfarm payrolls report to be released on Friday, and predict that the unemployment rate will remain stable at 4.1%. IG Australia analyst Tony Sycamore said: "The hard landing genie has one foot out of the bottle, and if tonight's nonfarm payrolls disappoint, it will soon become two feet. If the unemployment rate approaches 4.3% and new jobs slow to less than 100,000, then everything is over."

Swap markets have yet to factor in the Bank of Japan rate hike economists forecast

More worryingly, the interest rate swap market has yet to price in the pace and size of rate hikes that economists expect the Bank of Japan to make this year, meaning the yen’s rally may have only just begun.

The yen's two-year one-month swap was trading around 0.73% on Friday, suggesting traders expect only two 25-basis-point rate hikes from the current 0.25% over the next two years. It also means they expect the pace of rate hikes to be slower than Bank of Japan watchers predict. A Bloomberg survey showed 68% of economists expect the Bank of Japan to raise rates again in 2024, with 44% predicting a December hike and 24% predicting an October hike. About 20% predict a rate hike in January next year.

"The Bank of Japan has made it clear that it will continue to raise rates if the outlook meets expectations," said Masayuki Koguchi, executive fund manager at Mitsubishi UFJ Asset Management. The central bank also plans to reduce its bond purchases, and the resulting increase in debt supply will be a "fatal blow" to the market and could push yields higher, he said.

With traders expecting the Federal Reserve to cut interest rates three times this year amid weak U.S. economic data, a Bank of Japan rate hike could further narrow the yield gap between Japan and the United States, supporting the yen against the dollar.

After the yen's sharp rise this week following major central bank decisions, Japanese Finance Minister Shunichi Suzuki said the government will continue to analyze the impact of the yen's sudden strength on the country's economy. "The government will continue to analyze the impact of exchange rate fluctuations on the Japanese economy and people's lives, and will take appropriate countermeasures," Suzuki told reporters on Friday.

Suzuki said a stronger yen has both good and bad effects, but rapid currency fluctuations could increase uncertainty in business activities and have a negative impact on people's lives. Suzuki also expressed his views on the possible increase in debt repayment costs after the Bank of Japan's tightening measures. He said the government must ensure that it can fund necessary spending even if debt-related spending increases, and more efforts are needed to improve fiscal health.

Article forwarded from: Jinshi Data