According to the Futu News app, Ali Hossain, the fixed income manager of Putnam, previously issued a warning about the rise in Japanese interest rates last year, likening it to the 'San Andreas Fault' of the financial world. Now, his predictions of market volatility risks have been proven. After the sharp reversal of the Japanese yen carry trade caused by the rate hike in July, Hossain warned investors that they 'have just witnessed the first movement of this fault, and there will be more in the future'.

Hossain pointed out that investors may have overlooked the underlying reasons for the sluggishness of global stock, currency, and bond markets, despite the firm stance of the Bank of Japan and concerns about the slowdown of the US economy that sparked strong demand for the yen on August 5th. This includes the return of a large amount of overseas investments by Japanese funds as interest rates rise in Japan, the world's fourth largest economy.

Hossain emphasized that viewing the yen carry trade as a scapegoat ignores the beginning of a larger trend. He wrote that the monetary tightening policy of the Bank of Japan and its impact on global capital flows will have profound effects in the coming years. His company manages approximately $1.57 trillion in assets.

Figure 1

The sudden halt in yen carry trades led to the largest decline in the Nikkei 225 index since 1987 and boosted the stock market volatility index VIX. Economists have predicted that the Fed may need to cut interest rates by half a percentage point or take action during the meeting, which is typically a response in times of crisis.

It's worth noting that Federal Reserve Chairman Powell stated last month at Jackson Hole that the 'time for cutting rates has come,' and the Bank of Japan also hinted at further interest rate hikes in two research reports. BOJ Governor Kuroda expressed this view in his comments to the parliament. These developments have prompted forex strategists to reevaluate the outlook for the yen.

Christopher Wong, forex strategist at OCBC Bank, stated that these events have increased their confidence in lowering their expectations for the USD/JPY exchange rate, adjusting their year-end target price from 141 to 138. He explained that the Fed's rate cut cycle means that the policy rate differential between the Fed and the Bank of Japan will narrow.

As one of the institutions bullish on the Japanese yen, Macquarie Group Limited has lowered its year-end target price for the USD/JPY from 142 to 135, the lowest level since May 2023.

Standard Chartered Bank expects the USD/JPY to reach 140 by the end of this year, and to drop to 136 in the first quarter of 2025.

Despite the fluctuation of the USD/JPY exchange rate around 140, market volatility remains high. The expected rate cuts by the FED and the potential further tightening policies by the Bank of Japan may soon cause another market disturbance.

With nearly thirty years of investment experience, Hussein tends to increase shareholding in Japanese government bonds, as he believes that with the rise in yields, capital may flow back to Japan. He also suggests reducing holdings of US government bonds, citing the potential pressure as funds flow back to Japan from US institutions.

Hussein believes that the rise in Japanese bond yields may attract domestic large life insurance and retirement fund investors to shift from other high-quality government bonds to Japanese government bonds, which will readjust the global market demand.

Pacific Investment Management Company's Japan branch (Pimco Japan Ltd.) is also preparing to actively invest in Japanese ultra-long-term government bonds, the value of which has already been adjusted. Tadashi Kakuchi, the portfolio manager of the company's Japanese bond investments, said that despite the financial market turbulence in August, the Bank of Japan's monetary policy normalization remains unchanged, with the earliest expected "next rate hike to be in January next year".

Since the Bank of Japan implemented quantitative easing in 2013, the forward interest rate for ultra-long-term bonds has exceeded 3% for the first time. Kakuchi pointed out that the yield curve is still steep, and the time to purchase longer-term government bonds has matured. He mentioned that despite the recent easing of volatility, it is "still higher than before the Bank of Japan started policy normalization", and the existence of volatility is beneficial for proactive managers.

Figure 2

Due to weakened investment demand and the Bank of Japan reducing its purchase of government bonds, the supply-demand balance of long-term bonds is deteriorating. The Ministry of Finance is also considering shortening the maturity of government bond issuance, and it is expected that increased demand in six months will bring stability to the market.

See Figure 3