- According to SocGen, the turbulence could continue again due to the unwinding of the yen carry trade.
- Analysts pointed to the Japanese central bank, which appears to be prepared to raise interest rates further.
- A further unwinding of the yen carry trade could dampen enthusiasm for U.S. technology stocks, SocGen said.
The chaotic unwinding of the yen carry trade on the stock exchange, which led to the worst sell-off in two years in August, may not be over yet, according to Société Générale.
The European Bank pointed out that the Bank of Japan was likely to raise interest rates further – a development that shook the markets in early August.
Investors panicked after the Bank of Japan unexpectedly raised interest rates in late July. The move triggered an unwinding of the yen carry trade, a popular strategy in which investors borrowed money in Japan at extremely low interest rates to invest in other assets such as U.S. stocks.
The impact of that sell-off has faded, with major U.S. indices more than recouping their losses last month. But more turmoil may be ahead as interest rates in Japan appear to be “normalizing” after decades of deflation, says SocGen global strategist Albert Edwards.
Japan’s economy is also showing promising signs that another rate hike is in order. Wage growth in Japan has outpaced wage growth in the United States for the first time in over two decades, Edwards noted.
For the first time in decades, Japanese wage growth was higher than in the United States. SocGen
“We have always cautioned our readers to watch Japan closely as it has always been at the forefront of major market moves,” Edwards said in a note to clients on Tuesday. “Any normalization of Japanese interest rates would have a major impact on the market – not only in the short term (through the unwinding of the yen carry trade) but also in the long term as higher Japanese interest rates would restrict the export of investment flows,” he later added.
Some investors have already taken advantage of this opportunity, and a significant number of investors have closed their short positions in the yen in recent months. According to SocGen data, net open interest increased in August, suggesting that most investors are no longer shorting the Japanese currency.
A growing number of investors have closed their short positions in the Japanese yen. SocGen
Meanwhile, the U.S. economic outlook is bleak, Edwards said, which could hurt U.S. stocks. He pointed to weakness in the U.S. labor market last year and waning earnings optimism in the technology sector, which has accounted for most of the S&P 500 returns in recent years.
“Could the yen carry trade still hold? We need to keep a close eye on the other side of the yen carry trade, where a decline in technology prices can also end the trade. We are closely monitoring declining optimism about earnings in US technology stocks,” Edwards added.
Edwards has been predicting a recession and stock market crash in the US for months, although many economists say the economy is generally on solid footing. GDP beat expectations in the second quarter, while inflation continued to cool. Hiring, meanwhile, remains positive, and the unemployment rate is rising, but was still near its multi-decade low in July.
