Japan Faces Summer Market Volatility, Citibank Warns

Japan's bond market is not expected to collapse, but the country may face a temporary "stock, bond, and currency" downturn this summer, according to a recent report by Citibank. The report, released on June 3, suggests that while Japan's bond system is stable, the next 2-3 months could see significant volatility in the stock, bond, and currency markets. This potential downturn is attributed to various economic factors and market dynamics.

The report highlights that Japan's bond market has recently experienced significant fluctuations, with 30-year and 20-year bond yields reaching approximately 3.2% and 2.6%, respectively. Despite these challenges, the report emphasizes that the overall bond system remains robust and is unlikely to collapse. The recent price drop in Japanese government bonds (JGBs) has paused, and the report suggests that the yields are still attractive enough to meet domestic investors' expected returns, indicating a gradual recovery in demand.

The potential downturn in the stock, bond, and currency markets is a result of broader economic trends and market sentiment. The report warns that during the July parliamentary elections, market concerns about the Japanese government implementing more expansionary fiscal policies could increase, potentially worsening the fiscal situation. Additionally, concerns about the Bank of Japan lagging behind the curve continue to brew in the market, making the Japanese market more fragile in the coming months.

Citibank predicts that the Japanese yen could depreciate to around 150 against the US dollar in the next 2-3 months. If the yen's interest rates continue to rise and are followed by a stock market adjustment, Japan could experience a "stock, bond, and currency" downturn. However, the recent rise in yen interest rates is expected to improve the fundamental supply and demand situation of the yen, ultimately benefiting the currency. Citibank anticipates that the yen could strengthen to around 140 against the US dollar by October to December this year, presenting a strategic opportunity for investors to build long positions in the yen from a medium-term perspective.

The report underscores that Japan's market performance is heavily influenced by the US market. The correlation between the US dollar and the Japanese yen, the US dollar index, Japanese stocks and US stocks, and Japanese and US long-term interest rates is typically strong. Therefore, the likelihood of Japan experiencing a genuine "three-way downturn" depends on the developments in the US market. The report suggests that such an extreme scenario is highly unlikely in the near term, requiring a combination of a sharp decline in US stocks and an unusual surge in the US dollar, along with a chain reaction in the Japanese market.