Entering the Japanese market right now is like catching “a falling knife,” Kelvin Tay, regional chief investment officer at UBS Global Wealth Management, told CNBC’s “Squawk Box Asia.”
His comments come as the Nikkei 225 and Topix extended their slide, down more than 7% on the day and hovering near bear market territory.
“The only reason the Japanese market has gone up so strongly in the last couple of years is because the Japanese yen has been very, very weak. Once it reverses, you have to get out right and I think everything is coming out now as a result of that,” he said. Tay.
The yen, which fell to a 38-year low of 161.99 against the US dollar in June, reversed course in the run-up to the Bank of Japan’s policy meeting.
It rallied sharply after the BOJ raised its key interest rate last week to around 0.25% and decided to curb purchases of Japanese government bonds.
Currently, the yen it last traded at 144.82, its lowest level against the dollar since January. A stronger yen is weighing on Japanese stock markets, which are largely dominated by trading houses and export-oriented companies, eroding their competitiveness.
BOJ Governor Kazuo Ueda struck a hawkish tone during his press conference after the bank’s July 31 meeting, saying “if the economy and prices move as we forecast, we will continue to raise interest rates.” according to Reuters.
He also said there was “still some way to go” before his policy rate reached a neutral level that neither cools nor overheats the economy.
Ueda also said the 0.5% interest rate level—Japan hasn’t seen it since 2008—wasn’t an obstacle, and rates could go even higher.
The yen barometer
Tay said the yen could indicate whether the Japanese market will do well. As the yen has strengthened, stocks have fallen, “there’s still a lot more pressure on the Japanese stock market, unfortunately,” he said.
While Tay acknowledged that some of the market’s gains were due to corporate restructuring efforts by the Tokyo Stock Exchange, “the main driver was the Japanese yen.”
One factor why the yen has come up so strongly in the Japanese market is what is known as the unraveling of the “yen bear trade”.
When the yen was weak and interest rates from the BOJ were zero or negative, investors borrowed in yen and invested the proceeds in higher-yielding assets.
Using central bank benchmark rates as a guide, an investor could have borrowed yen at 0% earlier in the year and invested the money in the US, earning 5.25% interest.
Now, with the Federal Reserve signaling rate cuts on the table and the Bank of Japan raising rates, the interest rate differential between the two central banks will narrow, making the “carry trade” less attractive, potentially setting the stage for the yen. be further strengthened.
Tay expects the yen to reach around 143 to the dollar, but if Japanese life insurers and pension funds start repatriating more yen back to Japan, the currency could go to 135 to the dollar.
“Well yes [the yen] it might find a level, but right now, the Japanese stock market is still not attractive enough for me to really want to get in.”