Nikkei’s Largest Loss Since 1987 Black Monday

Japan's Nikkei 225 index plunged 12.40%, or 4,451.28 points, yesterday (Monday, 5 August) to close at 31,458.42 points. The Japan 225 (NIY) shattered the previous record set on the day after Black Monday in 1987, marking the largest point drop in its history and the second largest decline in percentage. 

Led by a sharp fall in financial stocks such as Mizuho Financial (8411. TY) and Orix (8591. TY), the Nikkei index has entered bear market territory, having dropped 27% from its peak of 42,426.77 points reached on Tuesday, 11 July.

Furthermore, other Asian stock markets also suffered steep losses on Monday. South Korea's Kospi index plummeted by 9%, triggering circuit breakers for the first time in over four years. Australia's market also took a severe hit with the ASX 200 (SPI) by losing 3.7%, enduring its worst two-day decline since the pandemic.

Let’s take a closer look at the potential reasons behind Monday’s indices’ sell-off:

Could the Bank of Japan Have Triggered the Nikkei’s Decline?

While other factors undoubtedly played a role, last week’s decisions from the Bank of Japan (BoJ) to increase interest rates to around 0.25% and reduce its massive bond buying appears to be the primary driver of the Japanese market crash. 

The hawkish stance adopted by the central bank in recent weeks is likely to have strengthened the Japanese Yen (JPY), potentially reversing years of currency weakness that had benefited Japanese exporters. Over 50% of Japan's output is exported, making a weaker Yen advantageous for Japanese businesses as it enhances the competitiveness of their products on the global market.

The Yen’s rapid appreciation, with the USD/JPY surging 14% in less than a month to reach a seven-month high of around 143 yesterday, may have triggered a mass unwinding of yen-carry trades. This occurs when investors borrow cheaply in Yen to invest in higher-yielding assets. 

The scramble to liquidate these profitable positions to cover losses elsewhere potentially exacerbated the Nikkei's decline, as a rising Yen usually puts downward pressure on Japanese equities. (Source: Reuters)

What Other Reasons Could Have Caused the Sell-Off?

Fears of a looming US recession likely exacerbated the market sell-off. Weaker-than-expected US job data with the Non-Farm Payroll report released on Friday, 2 August, revealed a significant slowdown in hiring and a rise in unemployment. 

This, coupled with softening US economic data in manufacturing and durable goods in recent months, has fueled concerns about a potential economic downturn in one of the largest economies in the world. Goldman Sachs (GS) has increased its probability of a US recession to 25% from 15%.

Additionally, the Federal Reserve's persistent hawkish stance has added to market anxiety. Traders are questioning the central bank's monetary policy path, especially as other major economies like Europe, Switzerland, Canada, and the UK have begun to cut interest rates.

The recent hype around Artificial Intelligence (AI) has boosted big tech stocks, such as Apple (AAPL), Amazon (AMZN), Alphabet (GOOG), AMD (AMD), Microsoft (MSFT), Meta (META) and Nvidia (NVDA). However, it has also contributed to recent market volatility. 

Initial optimism surrounding AI's potential to ignite a new industrial revolution has been tempered by the realisation of minimal profits and the technology's uncertain viability. Coupled with underwhelming financial performance from several tech giants during the recent earnings season has also supported market uncertainty.

Conclusion

Japan's Nikkei 225 index experienced its largest single-day decline since the 1987 Black Monday crash yesterday, Monday, 5 August, when it fell by 12.40%. Multiple factors contributed to this sharp downturn, including the Bank of Japan's hawkish policy adjustments, concerns over a potential US recession, and the unwinding of yen-carry trades. 

While the Nikkei rebounded sharply today (Tuesday, 6 August), gaining over 10% and seeing its best day since October 2008, volatility is expected to persist as traders assess the ongoing economic and financial landscape.