After a turbulent period for Japan’s markets, marked by a sharp drop in the Nikkei and a significant surge in the yen, the Bank of Japan (BOJ) finds itself at a critical juncture. As global investors and policymakers closely monitor the BOJ’s next moves, Louis-Vincent Gave, founder of Hong Kong-based Gavekal Research, offers a stark assessment: “At this stage, any intervention would be self-defeating.”
Gave’s comments reflect a sentiment widely shared among investors and analysts, particularly following the BOJ’s recent monetary policy actions. On 31 July, the central bank raised interest rates to 0.25 percent, a level not seen in 15 years, sending shockwaves through global markets.
Mixed signals from BOJ officials, including governor Kazuo Ueda and deputy governor Shinichi Uchida, only added to the uncertainty. However, Uchida has since clarified that investors should not expect any further rate hikes on the yen this year.
Precarious position
Gave argues that the BOJ is now in a precarious position where any further intervention could exacerbate the very volatility it seeks to control. According to him, the best course of action for the Japanese central bank is to allow market dynamics to play out. “They should simply wait and let the markets stabilise,” Gave told Investment Officer.
While this cautious stance carries risks, it recognises the potential for further market disruption if the BOJ takes a more active role. Uchida’s remarks following last week’s market crash underscore this. He emphasised that the BOJ would not raise interest rates when financial markets are unstable, signalling a clear priority for market stability over aggressive monetary tightening.
The Yen-US equity feedback loop
One of the most concerning aspects of the current market situation is the self-reinforcing feedback loop between the rising yen and the sell-off in US equities. According to a report by Gavekal, this loop is driven by the unwinding of yen-funded carry trades, which previously fuelled investments in US tech stocks and other high-risk assets.
“We have had two massive anomalies in the system: the yen was far too cheap, and the valuations of everything linked to AI and technology were far too extreme,” Gave explained. “This created very unstable equilibriums, and now the unwinding of the yen carry trade is causing many other asset classes to collapse.”
The end of the yen carry trade, according to Gave, means that the world is losing its last source of free capital. “Since 2008, investors have lived in a world where you could always find capital at almost zero cost. Now, suddenly, the idea that you can just borrow yen to buy any asset and make money has been shattered.”
The unwinding of these carry trades is putting further downward pressure on global markets, worsening the economic slowdown in the United States. This, in turn, leads to a further rise in the yen, as investors seek safe havens, creating a vicious cycle that is difficult to break.
Gavekal Research outlines four potential scenarios to break this feedback loop: the complete unwinding of yen-funded carry trades, intervention by Japanese authorities to slow the yen’s rise, a series of rate cuts by the US Federal Reserve, or the onset of a US recession.
The scenario now unfolding in the market appears to be a verbal intervention by Japanese authorities. With the BOJ clearly signalling that there will be no further rate hikes in the near future, these comments from BOJ officials seem to be a crucial step in temporarily halting the yen’s rise and giving the markets the breathing space they need to stabilise.
Louis-Vincent Gave is the founder of Gavekal Research. In 1998, he established the research firm with his father and Anatole Kaletsky, focusing on Asia’s growing influence on global markets. Gave is also the author of seven books, including Avoiding the Punch, which discusses investing in times of geopolitical tensions and economic uncertainty.
Further reading on Investment Officer Luxembourg:
- ‘We are in a market where DLR/JPY could move both ways violently’
- The carry trade: a popular but risky currency strategy
- Unfortunately, this is not the end of the carry trade