Exploring the Ripple Effects of Japan’s Monetary Policy Shift on Global Markets
An analysis by Presidential Advisor, Prof. Dr. Cosmin Marinescu
Source: cosmin-marinescu.ro
On Monday, August 5th, global financial markets were deeply shaken, in a day nearly as “black” as the one in 1987 in terms of stock market declines: the NASDAQ 100 index lost 6.45%, and the S&P 500 fell by 12.4%. On the same day, the VIX index, also known as Wall Street’s “fear index,” rose to 41.8%, reflecting volatility and anxiety in the financial markets. Anticipatory recessionary estimates for the US economy amplified the turbulence, but the root cause seems to be linked to the shockwave from Japan, highlighting how interconnected and vulnerable today’s financial markets truly are.
Japan is the fourth-largest global economy, marked by prolonged stagnation, in contrast with other developed economies. Over time, Japan’s monetary policy has been unconventional, characterised by near-zero interest rates in response to low inflation and sluggish economic growth. This monetary policy favoured a phenomenon known as “carry trade”: investors borrowed yen at low-interest rates and invested in higher-yielding assets, with the yen’s depreciation amplifying the attractiveness of this financial strategy.
However, the recent shift in Japan’s monetary policy, in response to unexpected inflation, has disrupted the economic and investment landscape. On August 1st, the Bank of Japan decided to increase the reference interest rate to 0.25% from 0.1%—a level set in March from 0% previously. This move led to a rapid appreciation of the yen against the US dollar, prompting the reconfiguration of financial strategies through significant portfolio adjustments, hence the increased tensions in global markets.
Japan, with a public debt exceeding 260% of GDP, faces fiscal constraints that severely limit the government’s capacity for economic stimulation without risking a severe sovereign debt crisis. Additionally, geopolitical tensions and ongoing conflicts in the Middle East amplify market volatility, affecting global supply chains and increasing inflationary pressures.
On Tuesday, August 6th, financial markets began to stabilise partially, indicating a slight improvement compared to the severe turbulence at the start of the week. The Tokyo Stock Exchange reported significant growth, with the NIKKEI 225 and TOPIX rising by 9.09% and 9.75%, respectively. In Europe, stock indices recorded partial recovery, with STOXX Europe 600 and EUROSTOXX 50 increasing by 0.17% and 0.13%. However, volatility remains high, clearly underscoring the profound impact of shocks and changes in monetary policy.
In this context of persistent volatility, the dependence on unconventional monetary policies and leverage becomes increasingly evident. The global economic system, already exposed to shocks, faces heightened counter-party risks, currency volatility, and increased liquidity pressures. These issues affect not only investors but also put pressure on financial institutions, highlighting the exposure of the global financial system to stock market turbulence.
Japanese banks, once pillars of “carry trade” strategies, are now caught in a storm of extreme volatility. On “Black Monday” 2024, Sumitomo Mitsui Trust Holdings, Japan’s second-largest bank, suffered a 15.5% collapse, and Mitsubishi UFJ Financial Group, the sector leader, fell by 12.2%. Then, on Tuesday, the stock market recorded recoveries of +8.43% and +5.82%, respectively.
The rapid losses and recoveries of these stock prices reflect the depth of the risks associated with investment strategies based on “artificially” low-interest rates and rapid fluctuations in monetary policy. In an era where banks are no longer mere spectators but active players in global financial markets, the volatility of these stocks underscores the fragility of a deeply interconnected and vulnerable economic system.
Current stock market turbulence and echoes of past crises can be seen as manifestations of the same “butterfly effect” in the realm of markets, indicating intense links between seemingly disparate phenomena in the global financial system.
Regardless of interpretation, it is clear that a profound review of investment strategies and the implications of monetary policies on a global scale is necessary, as demonstrated by the strongly inflationary context of recent years, amid “whatever it takes” monetary policy easing.
On Wednesday, August 7th, global financial markets began to recover slightly, although signs of instability still persist. In the United States, stock indices registered modest gains: the NYSE rose by 1.11%, the NASDAQ Composite by 1.03%, and the S&P 500 by 1.04%. In Europe, the recovery was somewhat weaker, with STOXX Europe 600 up by 1.02% and FTSE 250 by 0.82%. Asia saw a more significant recovery, with the NIKKEI 225 rising by 4.29% and TOPIX by 2.26% (see the table at the end of the text for variations of major global stock indices for August 5-7).
After “Black Monday” at the beginning of the week, when most markets entered negative territory (with a few exceptions in Europe, where selected indices managed to avoid severe declines), markets began to stabilize and return to positive territory. These developments capture the complexity of stock market systems and indicate the need for in-depth analysis to fully understand the global impact of recent fluctuations.
Asian markets set the tone for recovery, followed by rebounds in European stock exchanges. US markets still signal volatility, likely awaiting a Federal Reserve intervention to ease monetary policy, supporting economic growth and job creation.
However, although stock markets seem to be calming down, the underlying reality is complex and must be managed responsibly and prudently. Monetary policy, with all its nuances and subtleties, remains a sophisticated toolkit with profound effects and risks from one cycle to another. Certain decisions, even correct ones, can trigger global shockwaves, and the stock market stabilisation in recent days must be approached with caution. Therefore, fine-tuning exercises by central banks are imperative to avoid both overstimulation, which fuels inflation, and excessive tightening, which hampers the economy.
In such an interconnected world, where economic policies inherently obey the “law of unintended consequences,” the responsibility and prudence of policy decisions will support long-term economic stability. In the absence of perfect synchronisations, we must not underestimate the market’s capacity to surprise, often unpleasantly.
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