Japanese stocks experience "largest drop in four years", surging yen once again becomes the "center of attention", with 140 as the new market target?

After 24 hours of intense trading, the Japanese yen achieved its best monthly performance in over a year and a half. On Thursday, the yen against the US dollar briefly broke through the 149 level, reaching its highest level since March.

However, the strong yen severely dragged down the domestic stock market. On Thursday, Japan's TOPIX index saw its largest intraday decline since 2020, with the central bank's rate hike weighing on real estate stocks.

The Bank of Japan unexpectedly raised interest rates on Wednesday, while the Federal Reserve hinted at starting rate cuts as early as September, narrowing the US-Japan interest rate spread. Market attention has shifted back to the yen, with Amundi and Daiwa Securities predicting that the yen against the US dollar exchange rate could rise to 140.

Double Blow of Central Bank Rate Hike and Yen Surge, Japanese Stocks Experience "Largest Decline in Four Years," All Sectors Decline

On Thursday, August 1st, Japan's TOPIX index fell by 3.9% at one point, marking the largest intraday decline since April 2020, with all sectors experiencing declines. Real estate stocks fell by 8.1%, automotive stocks by 6.4%, and the department store sector, which had previously benefited from a weaker yen and a surge in tourism consumption, cooled off.

The Nikkei 225 index fell by 3.5% at one point during the day, narrowing to 2.5% by the close, as the index entered a technical correction phase last week.

"The Bank of Japan's rate hike has raised two major concerns: one is that the appreciation of the yen poses a resistance to exporters who have long benefited from a weaker yen; the other is whether the economy can maintain its strength," said Tetsuo Seshimo, portfolio manager at Saison Asset Management Co. "There are still many unknown factors."

As Japanese companies intensify the release of quarterly earnings reports, corporate profits are also putting pressure on the stock market. Toyota, Japan's most valuable company, contributed the most to the decline in the TOPIX index, as its stock price fell by 8.5% at one point due to lower-than-expected second-quarter operating profit.

At Wednesday's monetary policy press conference, Bank of Japan Governor Haruhiko Kuroda "turned hawkish," stating that if the economy and inflation support it, rate hikes will continue, and 0.5% is not a specific upper limit for interest rates.

Tomoichiro Kubota, senior market analyst at Matsui Securities, said, "Kuroda's demeanor at the press conference yesterday was like a different person, becoming more hawkish. The assumption that 'interest rates will not rise in Japan, and the yen will not appreciate' has changed."

Yen Once Again in the Spotlight, Most Predict a Rise to 140

Due to the significant shifts by the Bank of Japan and the Federal Reserve, Wall Street has rapidly turned bullish on the yen.

Analysts at Macquarie Group stated, "The strong upward momentum of the yen has just begun," and by the end of this year, the USD/JPY exchange rate could approach 140, soaring to 125 by December 2025. This would bring the yen against the dollar back to the levels seen at the beginning of 2022, when the Federal Reserve had just started raising rates "If the Federal Reserve starts a loose cycle, risk aversion sentiment rises, and the Bank of Japan maintains a firm tightening stance, the (yen against the dollar) exchange rate may rise to 140," said Paresh Upadhyaya, head of fixed income and currency strategy at Amundi USA. "Although this seems like a daunting obstacle, the reality is different."

After soaring nearly 2% on Wednesday, the yen against the dollar rose 1% to 148.51 on Thursday, with an increase of over 7% in the past month.

In the first half of this year, the US-Japan interest rate differential caused the yen to plummet by 12%, hitting a 38-year low in early July, making it the worst-performing currency among the G10 group, prompting Japan to intervene to support the yen in April and May.

Alex Loo, macro strategist at TD Securities, said, "Japan's tightening monetary policy will strengthen the feedback loop for local asset rebalancing," and he expects the yen to rise to 140 against the dollar in the first quarter of next year.

Christopher Wong, forex strategist at OCBC Bank, is also very optimistic, believing that a fair exchange rate for the yen against the dollar is 136.

Charu Chanana, head of forex strategy at Standard Bank, believes there is room for the yen to appreciate to below 145 this year, especially with increased volatility and short covering.

Shusuke Yamada, head of forex and interest rate strategy at Bank of America Securities in Tokyo, said the Fed is expected to cut rates, and the Bank of Japan is expected to raise rates to 0.75% next year, which will push the yen to trade around 140.

Strategist Sebastian Boyd said, "If the only pressure on the yen is the rate expectations of the US and Japan, then the yen is still cheap. From current levels, the yen has more room to rise, with models showing the yen should be much stronger than it is now."

It is worth noting that not everyone is bullish on the yen.

Tohru Sasaki, chief strategist at Fukuoka Financial Group, warned that although the yen may rise in the short term, when market focus shifts back to interest differentials and economic fundamentals, the yen may fall back to the 160 level.

Sasaki said, "If real interest rates remain significantly negative without turning positive, I think it will be difficult for the yen to appreciate even in the medium to long term."