Following the strengthening of the Japanese yen on Monday, several hedge funds began dumping Japanese stocks, signaling the end of popular long positions in the country.
Could it be that the direction of the yen is even more critical than that of the economy for the markets?
It’s hard to say whether this is more crucial, but it’s clear that Japanese stocks have become extremely sensitive to movements in the yen over the past couple of years. In simpler terms, where the currency goes, so does the market.
It is therefore not surprising that after the strengthening of the yen at the start of the week, the Nikkei 225 index also experienced a correction.
Similar movements have already been observed, notably before the March meeting of the Bank of Japan, during which the regulator was to announce a review of its monetary policy.
How much is the Nikkei affected by fluctuations in the yen?
According to some estimates, a 1% rise in the Japanese currency could cause the blue chip index to fall by around 2%. However, this effect tends to fade over time.
For example, although the USDJPY rate has increased by approximately 0.76% since the beginning of the week, the Nikkei index has only increased by 0.36%. It is therefore clear that relying solely on fluctuations in the yen to invest long-term in Japanese stocks can be risky.
As elsewhere and with any other instrument, it is impossible to guarantee the prediction of the direction of movement using a single indicator. It is necessary to have an overview.
So why should the index fall while the yen strengthens?
The rising yen puts pressure on exporters’ profits, which are crucial for the Japanese economy, given its heavy dependence on international trade.
Looking ahead, the unwinding of bearish bets on the yen by hedge funds and asset managers could strengthen the Japanese currency to 139 against the dollar by the end of 2024.
Additionally, further rate hikes by the Bank of Japan or government interventions could also favor the country’s currency. Another positive factor could be the Fed’s dovish rhetoric.
What should we pay attention to?
The Bank of Japan will release its current account forecast tomorrow, which could help determine whether authorities intervened in the foreign exchange market on Monday.
If so, it suggests that the regulator is ready to intervene if necessary and therefore bearish investors should exercise caution. Otherwise, the fall of the yen could resume.
The problem is that the consumption of foreign exchange reserves is only temporary, which should not lead to a reversal of the situation. Ultimately, the government will simply exhaust the funds.
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