On August 25, in the wake of Federal Reserve Chairman Jerome Powell's clear indication just two days prior at the Jackson Hole annual conference that interest rate cuts are on the horizon, the Fed has made a dramatic pivot from its hawkish monetary policy stanceThis shift comes after a grueling series of 11 rate hikes over the past two years, pushing the benchmark rate to its highest level for this century, between 5.25% and 5.5%. The implications of this sudden turn have sparked various predictions in the financial marketsAccording to the CME's FedWatch Tool, there is now a 24% probability that the Fed will cut rates by 50 basis points in mid-September, while a staggering 76% expect a more modest cut of 25 basis points.

Market forecasts suggest that further interest cuts could occur in September, November, and December, with expectations that rates could drop to between 3.75% and 4.00% by the year's endThis translates to a theoretical total of 150 basis points in cuts over the remainder of the year.

Analysts believe the Fed will strive to ensure that establishment candidates in the U.S. are not distracted by potential market crashes before the crucial election set for November 5. They might orchestrate what could be described as an epic dollar celebration before November, which could potentially elevate asset prices on Wall Street and in several other global markets already entering a rate-cut cycle

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Conversely, this could create significant turbulence in the Japanese market, which is embarking on a rate hike phase while an influx of capital might flee from Japan in favor of markets engaged in monetary easing.

A new development came to light on August 23, when recent statistics were released indicating that Japan's inflation rate has surged due to the government's temporary suspension of subsidies for electricity and natural gasEnergy costs have risen significantly, and as a consequence, Japan's core inflation rate accelerated for the third consecutive month in July, remaining above the Bank of Japan's (BOJ) targeted 2%. The core consumer price index, which excludes fresh food, jumped 2.7% compared to the same month last year, up from 2.6% in June.

Compounding these issues, as of August 25, warnings of a potential massive earthquake have led Japanese consumers to stockpile essential goods and food suppliesBeyond water and emergency kits, rice has seen extraordinary buying frenziesPeople across Japan have noted a significant shortage of rice in supermarkets, with shelves largely empty and some even marked with purchase limitsThis phenomenon has been dubbed the ongoing "Reiwa Rice Panic." The Japanese Ministry of Internal Affairs announced this week that the national consumer price index for July shows a 17.2% increase in rice prices compared to a year earlier, marking the largest jump in 20 years and leading to the highest rice prices in over a decade.

This situation sheds light on the recent remarks by Bank of Japan Governor Kazuo Ueda on August 23, where he reiterated that as long as the economy continues to progress toward the stable inflation target of 2%, the BOJ will maintain its policy normalization

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Following the BOJ's unexpected decision to raise rates by 0.25% at the end of July, the possibility of further rate hikes this year remainsThe BOJ’s transition away from a decade-long policy of monetary easing, including a zero-interest rate environment and negative interest rates, marks a stark contrast to the Fed's easing stance and global trends in monetary policy.

Simultaneously, the yen is facing upward pressure, with potential risks of plummeting prices for yen-denominated assetsOn August 25, the exchange rate stood at 144 yen to one dollar, indicating an 11% increase since the yen hit a low of 162 in JulyInstitutions such as Mitsubishi UFJ Securities and Nomura anticipate that the USD/JPY exchange rate could eventually reach around 120 next year, suggesting over a 15% appreciation in the yen, with significant implications for yen asset valuationsConsequently, a narrative has emerged in Japanese media regarding a potential influx of funds from Japan into the U.S. and Chinese bond markets.

Signs indicate that as the Federal Reserve's inclination toward rate cuts strengthens, alongside the People's Bank of China moving towards its own cuts, Japanese investors are increasingly purchasing U.S. and Chinese bondsThe Japanese Ministry of Finance disclosed on August 22 that for the week ending August 17, Japanese investors net bought 18.5 trillion yen (approximately $128 billion) of overseas long-term debt securities, the highest level since mid-MayThis marks the third consecutive week of net purchases, propelled by rising expectations for Fed rate cuts, which in turn is likely to boost U.S. bond prices.

Data reveals that from January to June of this year, Japanese investors net bought U.S. bonds worth 74.1 trillion yen, marking the fourth-largest half-year total since 2014. It's noteworthy that in the first half of 2022, Japanese investors had sold off foreign bonds to mitigate losses stemming from rising global interest rates, resulting in a record net sell-off of 12 trillion yen in U.S. bonds during that period

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However, many are now rebuilding their positions as the Fed is anticipated to conclude its tightening cycle.

Naokazu Koshimizu, a senior interest rate strategist at Nomura, pointed out that banks raising dollars in the repo market have been purchasing American mortgage-backed securities and similar assets in the first half of 2024. Despite traditional caution on currency hedge costs from insurers—historically significant purchasers of U.S. bonds—a growing number of other buyers are keen to investAkihisa Abeta, a director at Manulife Investment Management, stated, “Pension funds and other institutional investors remain interested in purchasing U.S. bonds, primarily investment-grade corporate bonds.”

Importantly, data from Japan's Ministry of Finance reveals that Japanese investor interest in Chinese long-term bonds has also been robustIn the first half of this year, Japanese investors net purchased 667.6 billion yen in Chinese bonds, the highest level since 2014, indicating a significant acceleration of Japanese capital influx into China.

Meanwhile, from January to June, Japanese investors net sold 19.6 trillion yen in European bonds, marking the second consecutive half-year of salesThis included 8.989 trillion yen in German bonds and 9.862 trillion yen in Dutch bonds, both representing their highest figures over six months since 2019 and 2014, respectively

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