Investment Review №350. A Shift in Priorities

Nearly two years ago, on July 31, 2024, the Bank of Japan surprised markets with a rate hike. A weak U.S. employment report followed on August 2, and over four trading days the yen strengthened from 152.78 to 141.69 per dollar. The VIX “fear index” jumped from about 17 to nearly 66, the S&P 500 lost 5.8%, and Japan’s Nikkei fell 12.4% in a single session. The trigger was a broad carry-trade unwind: investors had been borrowing low-cost yen—after years of near-zero rates—converting to dollars, and buying risk assets, increasingly equities rather than the usual fixed income. When the yen appreciated sharply, forced deleveraging set in as positions were sold to repay more expensive yen liabilities, turning a currency move into a global equity sell-off.  

Today, the same dynamics are playing out—albeit at a larger scale. The dollar trades around ¥163.9, putting the yen at a 40-year low. Hedge funds’ net short bets against the yen have reached about $11.3bn, an almost nine-year high, while the Bank for International Settlements estimates the total short exposure, including derivatives, at $261bn to $1tn. The calendar also invites volatility: on Wednesday the Fed announces its decision; under new Chair Kevin Warsh and with oil above $100, a surprise hike is plausible (the market assigns a 36% probability). On Friday, the Bank of Japan meets; no change is expected, but surprises often arrive when conviction is strongest. 

The BoJ has lifted its policy rate to 1% for the first time since 1995. Japan’s Ministry of Finance spent $72.5bn on FX intervention in April–May and has pledged further “decisive measures.” Yet authorities are contending not only with speculators but with persistent domestic outflows. 

Through tax-advantaged NISA accounts (the local equivalent of the IIA), households bought ¥10.4tn of foreign equities in 2024 and another ¥9.4tn in 2025. With more than half of household savings—about ¥2,200tn (~$14tn)—still parked in deposits, this tendency may continue. 

Historical market episodes underscore the market’s vulnerabilities, and investors should remain prepared for them, even as the S&P 500 has recovered its losses over the past two weeks. Such episodes are most damaging for leveraged traders: margin calls can force exits before any rebound. In spring 2024, shortly after the Nikkei 225 posted its first new all-time high since 1989, I highlighted the appeal of the iShares MSCI Japan ETF (EWJ). Since then, the fund has appreciated by roughly one-third. We remain constructive on Japanese assets over the long term, but August 2024-style corrections will recur, and investors with portfolio exposure should be prepared for implications. For retail investors, maintaining a hedge—e.g., 1–2 month put options on Japanese ETFs—and monitoring USD/JPY is prudent: a 3–4% yen spike over a few days has historically been an early warning of equity sell-offs. And diversification still matters—Japanese investors themselves favor U.S. stocks.

We agree: our early-July strategy note set a 12‑month S&P 500 target of 8,150.