Asia wrap: Japan stocks lead the charge in Asia, fuelled by a weaker Yen and wall street gains

Riding the wave of a weaker yen, Japan's stocks led the charge in Asia on Friday, with the Nikkei 225 surging over 3%, setting the stage for its best week in four years. This rally followed Wall Street's overnight gains, spurred by robust economic data that eased fears of a looming recession and hinted that the U.S. economy might be on track for a soft landing.

While well-known business publications hint at a return to the carry trade, it’s not quite the case. It is how FX markets work. Since 2006, both human and algorithmic traders have closely watched the yen, reacting in real-time to the twists and turns of the global risk markets. When the stock market dives, so does X/JPY; when risk assets soar, so does X/JPY. This behaviour has turned the yen's movements into a self-fulfilling prophecy—a cycle where expectations drive reality. In other words, it reflects a risk on trade that can create overshoots on USDJPY. That said, we will likely see some “Johnny come lately" demand moving into cyclical currencies funded by the yen, keeping USDJPY supported today.

However, the plot thickens after the Bank of Japan's (BoJ) dovish waxing last week stabilized market conditions and might nudge the BoJ to consider further policy normalization, especially as the yen edges above the 150 level.

Indeed, the rules have changed, and those in the know understand that what might seem like a market crisis is often just another golden opportunity, courtesy of central banks’ uncanny ability to steer market sentiment.

While a rate hike in September seems unlikely—especially after the recent shockwaves in Japanese equities—the odds of a hike by the end of 2024 have jumped from 0% to 30%, by my calculations. The market is starting to factor in the possibility that the BoJ could shift gears sooner than anticipated as the economic landscape continues to evolve.

The yen's trajectory remains a pivotal storyline in the global financial narrative, and all eyes are on the BoJ’s next move. This could limit the USDJPY topside move. 

I suspect the USD/JPY saw an overshoot via the risk on X/JPY demand rather than a calculated move. Unfortunately, for a full-on bear assault on the dollar, the surprisingly strong US data may have put to rest talk of a 50bp cut in September; hence, we could hold off until the Jackson Hole pow-wow or NFP.