Analysts warned about the fallout from a surging yen. But then this happened.

By Jamie Chisholm

Critical information for the U.S. trading day

Fed week has delivered bigly for the bulls.

The U.S. central bank's jumbo interest rate cut on Wednesday has revived risk appetite, pushing the S&P 500 SPX and Dow Jones Industrial Average DJIA to fresh record highs.

It's a stark contrast to several weeks ago when global equity markets suffered a savage pullback at the start of August as a scare about the health of the U.S. economy dovetailed with a sudden surge in strength for the Japanese yen (USDJPY).

Recall, a big fear was that yen carry-traders - who borrowed the Japanese currency to buy higher yielding assets elsewhere - were being forced to dump their positions, creating a cascade of selling.

And in particular it was thought at the time that the reason technology stocks took such a battering was because a favored hedge fund trade was to borrow yen to buy the momentum-driven big tech names. This may partly explain why the Nasdaq Composite COMP still sits 3.40% below the peak hit in July.

Concerns rose that the rising yen amid a cycle of policy tightening by the Bank of Japan, albeit cautious, would encourage the Japanese liquidity spigot to reverse, sucking funds from popular investments, notably U.S. assets, for quite a while.

And yet. "The 10% Japanese yen (JPY) gain vs. the U.S. dollar during late July and early August has unleashed the largest seven-week buying of overseas assets from Japan, ever," says Stephen Spratt, rates strategist at Société Générale in a new note.

Data from Japan's Ministry of Finance shows Japanese funds "have been piling into overseas assets, buying a record $83.5bn in overseas stocks and bonds in the seven weeks following the JPY rally," says Spratt.

For example, the latest MoF data shows that in the week to September 13, Japanese funds bought -Yen2.1 trillion ($14.9 billion) in overseas bonds, the largest weekly flow since May. That took the seven-week net bond buying flow to -Yen9.1 trillion ($63 billion), which is a new record.

"This data runs counter to some market speculation that the rally in JPY will see domestic investors responding by repatriating foreign asset holdings or raising FX hedges. MoF data suggests they are doing the opposite," says Spratt.

Furthermore, Spratt notes that the continuing desire for Japanese investors to buy overseas assets comes despite low levels of hedging to protect the investment from foreign exchange moves.

"Widening rate differentials and the structural position of Japan as the world's largest creditor has left FX hedge costs punitive for Japanese investors. A weakening currency has also made owning unhedged assets more appealing. Neither of these trends have materially changed at this stage," he says.

Indeed, according to the Bank of Japan the country's life insurers by the end of last year had reduced their forex hedges to the lowest since at least 2011. Pension funds' holdings of forex-hedged bonds are now a tiny proportion of their bond portfolios.

All of this suggests that even without the hedging protection the recent rally in the yen has still not been enough to spook Japanese investors from parking funds abroad.

And the area which Spratt thinks has benefited notably from the resurgent export of Japanese capital is U.S. government bonds. "The size of this flow may have contributed to the Treasury rally with 5-year yields lower by 21 basis points in August and 23 basis points so far in September. The past four months have seen the largest rally since March 2020," he says.

Still, Spratt offers an important caveat. Just because there is no sign so far of Japan's investors repatriating funds that may because the big institutions take a long time to shift strategy.

"Given the size of the investors involved, we expect changes to be slow moving and would compare the change in portfolio trend as more akin turning a tanker than a speedboat," he says.

Markets

U.S. stock-indices are opening slightly lower as benchmark Treasury yields BX:TMUBMUSD10Y nudge higher. The dollar index DXY is gaining, while oil prices (CL.1) slip and gold (GC00) is trading around $2,615 an ounce.

   Key asset performance                                                Last       5d     1m      YTD     1y 
   S&P 500                                                              5713.64    2.11%  2.57%   19.79%  31.95% 
   Nasdaq Composite                                                     18,013.98  2.53%  2.24%   20.00%  36.22% 
   10-year Treasury                                                     3.723      6.60   -8.10   -15.79  -71.68 
   Gold                                                                 2631       0.95%  3.23%   26.99%  35.28% 
   Oil                                                                  71.06      2.63%  -5.20%  -0.38%  -21.33% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

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The buzz

Traders are braced for volatility as more than $5 trillion in options are set to expire in Friday's latest 'triple witching'.

Nike shares are up about 6% after the sneaker maker said it would replace Chief Executive John Donahoe with company veteran Elliott Hill next month.

FedEx shares are down 13% after the package-delivery giant tempered its full fiscal-year outlook, citing "weaker-than-expected" shipping demand as businesses worldwide remain cautious on the economy.

Shares of Mercedes-Benz Group (XE:MBG) are down 7% after the German carmaker made another cut to its full-year guidance, citing a slowdown in car sales caused by a slump in China's economy.

The Bank of Japan kept its overnight call rate at around 0.25% and the Nikkei 225 equity index JP:NIK rose 1.5%, while the yen (USDJPY) is down 0.7%.

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The chart

Money market fund assets under management continue to hit highs. The chart below from Ryan Grabinski and Jonathan Byrne at Strategas Securities shows the estimated inflation adjusted income from these funds.

"The passive income being generated from these accounts is stimulative in nature, but now that the Fed cut rates, we've likely seen peak passive income," says Strategas. "Periods in the past where this has rolled over were associated with economic softness," they add.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

   Ticker  Security name 
   NVDA    Nvidia 
   TSLA    Tesla 
   GME     GameStop 
   DJT     Trump Media & Technology 
   AAPL    Apple 
   NIO     Nio 
   PLTR    Palantir 
   TSM     Taiwan Semiconductor Manufacturing 
   HOLO    MicroCloud Hologram 
   TNON    Tenon Medical 

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-Jamie Chisholm

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09-20-24 0930ET

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