Nomura: BOJ's timing for rate hike is appropriate, arbitrage trading unwinding not yet complete

According to the Zhitong Finance APP, a senior executive at Nomura Holdings stated that the Bank of Japan's decision to raise interest rates last week was appropriate. He mentioned that if the Bank of Japan waited longer, the closure of arbitrage trades would cause much greater damage to the financial markets.

Christopher Willcox, head of trading and investment banking at Japan's largest securities firm, expressed in an interview on Wednesday, "The Bank of Japan has been proven to be correct." He indicated that there are still more arbitrage trades that need to be closed.

Due to the recent tightening of the Bank of Japan's monetary policy, which seemed to trigger a historic plunge in the Japanese stock market and led to global market turmoil, the central bank is facing public pressure. The benchmark Nikkei index experienced two consecutive record declines before rebounding on Tuesday, as investors were concerned about further interest rate hikes and yen appreciation.

Willcox mentioned that there is still room for further closure of so-called arbitrage trades (investors borrowing low-interest rate currencies and then investing in markets with higher yields) after many traders closed their positions following the Bank of Japan's rate hike.

"If they don't start taking action, the scale of arbitrage trades will only grow," Willcox said. "The Bank of Japan is very smart."

Arindam Sandilya, co-head of global foreign exchange strategy at JP Morgan, estimated on Tuesday that about 50%-60% of arbitrage trades have been closed. However, Willcox believes that it may be "more than that."

Willcox stated that recent market volatility is mainly due to the perception of higher risks of a US economic recession and expectations of more proactive measures by the Federal Reserve, rather than the actions of the Bank of Japan and the movement of the USD/JPY exchange rate. He expressed his belief that the US will avoid an economic recession.

As Japan emerges from decades of deflation, Bank of Japan Governor Haruhiko Kuroda has been gradually exiting the massive monetary stimulus program of recent years. Some politicians have urged the Bank of Japan to take action to normalize policy, as the weak yen has weakened the purchasing power of Japanese households.

"USD/JPY has put pressure on the Bank of Japan. The deflationary environment in Japan seems to be resolving. But they have always known that this easing would be very difficult," Willcox said.

In early trading on Wednesday, the USD/JPY exchange rate hovered around 147.02. Since the end of June, with expectations rising for a rapid narrowing of the significant interest rate gap between Japan and the US, the yen has risen by about 11%.

Willcox expects the exchange rate to be around 148 by the end of the year and possibly reach 140 next year, which is also the level he predicted in March.

In early trading on Wednesday, the Nikkei index rose, while Nomura's stock price increased by 2%. Nomura fell by about 19% on Monday, marking the largest drop in at least 50 years, but rebounded by 11% on Tuesday as the benchmark index recovered.

Any sustained selling in the stock market will harm Japanese securities firms. Earlier this year, the Japanese stock market rebounded to record highs, driving investment recovery, from which these securities firms have benefited. Boosted by wealth management as well as trading and investment banking businesses, Nomura's net profit for the last quarter exceeded analysts' expectations However, Willcox said, "We are not satisfied with the recent performance at all." The bank's wholesale division - including global trade and investment banking businesses - has been recruiting employees and trying to control expenses.

Data shows that the pre-tax profit of the wholesale business was 21.1 billion yen, a tenfold increase from the same period last year, but still a long way from its full-year target of 130 billion yen.

He said, "We are controlling costs, investing in risk management, but we are also actively investing in the business."