Call it the Bank of Japan butterfly effect. The central bank’s rate hike to 0.25% from 0% to 0.1%, along with commentary suggesting more tightening to come, has spurred financial convulsions at home and beyond: The Tokyo Stock Price Index (Topix) lost the most points in history today
The violent response to such an ostensibly modest policy tweak is instructive, particularly considering that interest rate futures had priced 70% odds of a hike one week ago. While the BoJ cited persistent currency weakness as a driving factor in its further foray into positive nominal interest rates, the recent trend reversal reverberates far and wide. Thus, the yen’s explosive, 9% four-week snap back against the dollar, in the wake of a near 60% selloff spanning the start of 2021 through early July, puts the hurt on carry trade positions, in which investors borrow low-yielding yen to invest in higher yielding jurisdictions such as the U.S.
It's the rate of change [of interest rate differentials] that matters, so if the BoJ are stepping up the pace of rate hikes relative to market pricing, and if the Fed is also becoming in play for rate cuts here, then the pressure on the carry trade increases. An influx of income-seeking foreign capital has provided a persistent tailwind for stateside stocks, the unwinding of that dynamic reciprocally presents un-bullish implications.
The now evident vulnerability of U.S. equity prices to a rise in the yen exchange rate warns of the consequences for U.S. asset prices and developed-world asset prices in general from monetary policy changes in the East, A narrowing interest rate differential, rather than the wholesale repatriation of capital by income seeking Japanese investors, has driven the recent FX snap back,
