【MACRO Insight】Recent Bloomberg survey warns of high leverage and exchange rate volatility in the Japanese stock market—caution urged for potential central bank market adjustments!

A recent Bloomberg survey indicates that about one-third of economists predict the Bank of Japan may announce a rate hike at its policy meeting in July, along with detailing its quantitative tightening (QT) plan. Among the 43 economists surveyed, 33% anticipate an increase in the upper limit of the policy rate from the current 0.1%.

Despite some economists believing in June that announcing both a rate hike and QT details in July seemed unlikely, the survey also shows an increased expectation of a rate hike in October, now at 42%. Mizuho Securities' Chief Japan Economist Ayako Fujita suggests rising inflation risks may increase the costs of delaying monetary policy adjustments.

Bank of Japan Governor Kuroda recently indicated that a rate hike in July is possible if economic data supports it, aligning with the tone of discussions from the June meeting minutes. Some market volatility is expected around that time. The Bank of Japan plans to hold meetings with market participants on July 9th-10th to discuss a two-year plan to reduce bond purchases. Analysts expect monthly bond purchases to gradually decrease starting from August, ultimately reaching 30 trillion yen.

Opinions among respondents vary regarding the pace of tapering, but there is a general expectation that bond purchases will decline gradually. Currently, the Bank of Japan holds approximately half of Japan's outstanding public debt, totaling about 584 trillion yen. Economists predict an approximately 11% reduction in bond holdings over two years, although the central bank will still maintain a significant amount, limiting its impact on the market.

Meanwhile, there's a high leverage warning in the Japanese stock market! Despite a 4% drop in the Nikkei 225 index since its March peak, retail investors' margin buying positions have hit a new high since 2006, reaching 49.1 trillion yen. Such high-leverage investments appear risky amid sluggish economic growth and expectations of central bank rate hikes, as investors could face forced liquidation if the market declines. Currently, retail buying positions are 6.4 times larger than selling positions, well above historical averages, reflecting excessive optimism in the stock market.

Market analysts caution that as earnings season approaches, disappointment in corporate profits could trigger selling by highly leveraged margin buyers. Strategists from Mitsubishi UFJ Morgan Stanley Securities point out that high-risk positions established earlier this year with six-month terms may be liquidated by September. Additionally, if the Bank of Japan raises rates next month to the highest level since 2008, increased margin costs could exacerbate market volatility.

Despite the current low proportion of margin positions to total market value, the recent leveraged buying brings to mind the situation in 2006, when a weak yen, rising commodity prices, and central bank rate hikes culminated in the Lehman crisis. Historical experience reminds us that excessive leverage in investments may pose systemic risks.

In this backdrop, the USD/JPY exchange rate has approached the crucial 160 level, increasing the likelihood of intervention by Japanese authorities in the foreign exchange market. Despite a 12% decline in the yen this year, Japanese officials have so far limited themselves to verbal warnings. Market expectations suggest that Japanese authorities will wait until Friday's release of the US PCE price index before deciding on intervention, as PCE data is crucial for US interest rate prospects.

Japan has already expended significant sums in forex interventions, and the weakening yen is affecting consumers and businesses. Monetary officials emphasize readiness to intervene at any time but have not set specific exchange rate targets. Analysts believe intervening prematurely carries substantial risks. The interest rate differential between the US and Japan is cited as the main reason for the yen's weakness. Analysts at Citigroup note that the timing and extent of Japanese intervention depend on the speed of yen depreciation and exchange rate levels.

The Ministry of Finance will decide on intervention, with the Bank of Japan acting as the implementing agency. Citigroup predicts that if the exchange rate rapidly approaches 162, Japan may intervene; if appreciation is slow, intervention is less likely. Strategists suggest intervention may be more effective during periods of liquidity shortage. Friday's PCE data is expected to show cooling US inflation, potentially supporting reasons for Fed rate cuts and easing yen pressure. Nonetheless, with the yen nearing the psychological threshold of 160, Japanese authorities may consider intervention post-data release. Market analysts therefore urge investors to exercise caution and be wary of potential market adjustments.

Overall, most economists predict that the Bank of Japan may raise interest rates in July and announce a quantitative tightening plan, while remaining cautious about the risks of high leverage in the stock market and fluctuations in the yen exchange rate. Despite a 12% decline in the yen this year, Japanese officials have only issued verbal warnings, with expectations that they will decide on forex market intervention based on Friday's US PCE price index. Economists and analysts urge investors to exercise caution regarding potential market adjustments.