The Bank of Japan has issued a dovish signal, focusing on trading opportunities in the Nikkei index and the yen

The Deputy Governor of the Bank of Japan made unexpected dovish remarks on Wednesday, stating that interest rates would not be raised during periods of market instability. This statement directly led to a sharp decline in the yen exchange rate, with the dollar rising more than 2.5% against the yen, hitting a recent low for the yen. Meanwhile, global stock markets were also boosted by the dovish remarks and the depreciation of the yen, with the Nikkei 225 index significantly rising, recovering from Monday's losses.

In March of this year, the Bank of Japan raised interest rates for the first time in 17 years, ending its ultra-loose policy. Since July 31, the Bank of Japan's interest rate hikes have led to a significant appreciation of the yen, prompting large-scale unwinding of yen financing arbitrage trades, which had a major impact on global markets and resulted in the occurrence of 'Black Monday'.

How Large is the Yen Arbitrage Trading Scale?

The collapse of yen arbitrage trading coincided with the crash of U.S. tech stocks, leading the market to believe there is a connection between the two. After all, since early July, the 11% rise in the yen exchange rate has been in sync with the 13% maximum pullback of the Nasdaq 100 index.

Since currency trading is not tracked as centrally as stock trading on exchanges, nearly all cross-asset market participants, from hedge funds and family offices to private capital and Japanese companies, engage in this type of trading. The exact scale of this strategy is currently uncertain, and there are many assessment methods in the market, with rough estimates potentially reaching hundreds of billions or trillions.

According to data from the Bank for International Settlements (BIS), as of March, Japanese banks had lent approximately the equivalent of $1 trillion in yen to foreign borrowers, a 21% increase from 2021. A significant portion of the growth in cross-border yen lending has occurred in the interbank market, in addition to lending to non-bank financial institutions such as asset management companies. Furthermore, some market views suggest that the Japanese government is actually the largest yen arbitrage trader in the market, with the scale of yen arbitrage trading reaching $20 trillion, although this figure includes the total value of the Japanese government's balance sheet, which may be exaggerated.

Although the exact figures are difficult to determine, the scale of yen arbitrage trading is undoubtedly large and has a significant impact on global financial markets.

Has the Unwinding of Yen Arbitrage Trading Ended?

Recent market turmoil has demonstrated the widespread influence of yen carry trades. Different financial institutions have varying views on the future of yen carry trades.

J.P. Morgan believes that the current unwinding of arbitrage trades is only about 50% complete, warning that short-term volatility has not truly ended, just that the pace is currently slower than before. They emphasize that the yen, as one of the most undervalued currencies, still has significant upside potential.

UBS, on the other hand, holds a more pessimistic view, believing that the unwinding of carry trades has only just begun, and the yen may continue to strengthen in the future. They expect the dollar-to-yen exchange rate to decline further and believe that the Bank of Japan may continue to gradually raise interest rates.

Goldman Sachs takes a more optimistic stance, believing that the pressure from unwinding yen carry trades has basically been alleviated. They point out that the market has absorbed most of the unwinding pressure, and future volatility may decrease. Additionally, Goldman Sachs believes that the Nikkei index is attractive at its current level, and the market may be close to a bottom.

The recent crash in the Japanese stock market is largely a direct result of the large-scale unwinding of yen carry trades in the short term, rather than a fundamental deterioration in the U.S. economic outlook. With the Bank of Japan sending dovish signals, bringing positive signals to the market, close attention should be paid to the fluctuations of the Nikkei index and the yen exchange rate, as these indicators not only reflect the delicate balance of the global financial market but also provide potential trading opportunities for investors.

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