Singapore Exchange (SGX Group) listed a new three-month Tokyo Overnight Rate Average (TONA) futures contract in the week that the Bank of Japan increased its benchmark interest rate for only the second time since 2007, leading to a spike in trading volumes.

On Wednesday 31 July the Japanese central bank increased interest rates to 0.25% from the previous range of 0% to 0.1%.

Godzilla Returns

In a desperate bid to save their falling currency, the Japanese have begun hiking rates. USDJPY has begun collapsing, and with it, the carry trade that held up their massive overleveraged economy.

A THREAD 🧵🔥👇 pic.twitter.com/Ulup7gE74s

— Peruvian Bull (@peruvian_bull) August 4, 2024

SGX said in an email that the new TONA contract achieved a total cumulative volume of 2,560 lots between its debut on Monday 29 July until the end of the trading session on Friday 2 August at 5:10 pm Singapore time. Between the contract’s listing and the interest rate rise, the traded volume of the contract had been a much lower 532 lots.

In addition, SGX said open interest in SGX mini Japanese government bond futures has increased 26% over the past month.

In foreign exchange, SGX said the exchange achieved a $25.7bn single-day record for USD/renminbi (CNH ) futures amidst turbulent market conditions on 25 July.

“Surpassing the previous record by 15.1%, SGX FX’s latest achievement underscores the need for a highly liquid venue for global investors to manage currency risks,” added SGX. “The notional open interest for USD/CNH contracts also saw a notable uptick of 3% to 213,814 lots, closely approaching the historical high of 219,005 lots set in June 2024.”

But the other reason why Japan built up such a massive carry trade- (which Deutsche Bank analysts estimated at a staggering $20T USD equivalent!) is because of the lack of volatility in the monetary policy itself. pic.twitter.com/gQoZBGXtnM

— Peruvian Bull (@peruvian_bull) August 4, 2024

This tough stance pushed the dollar below 151 yen for the first time since March. pic.twitter.com/8F39I3eDEb

— Peruvian Bull (@peruvian_bull) August 4, 2024

All the USDJPY carry traders, who are functionally short the Yen on the funding leg, now are getting stopped out as the squeeze begins.

— Peruvian Bull (@peruvian_bull) August 4, 2024

Japanese equities

SGX’s Nikkei 225 index futures saw 52.5k lots, or notional of $6.8bn traded on 31 August, an increase of 36% over the daily average for July 2024 according to the exchange. 

Japan's Topix and Nikkei indexes both finish the day down more than 12%, the most since Black Monday in 1987. Worse than Covid! Worse than 3/11! Absolute carnage. Hold your loved ones. pic.twitter.com/J4rR29mXu2

— Gearoid Reidy リーディー・ガロウド (@GearoidReidy) August 5, 2024

Naka Matsuzawa, chief strategist at Japanese bank Nomura, said in a report that the steep drop in Japanese equities was not the result of the market pricing in a deteriorating economy, but the erasure of the boost from weak Japanese yen.

He expects Japanese equities to continue testing downside, with foreign demand-related equities driving the decline and the focus likely to be on the resilience of bank stocks.

“Of course, we should not make any assumptions since volatility is substantial compared to other markets as a result of higher volatility in the FX market and the reversal of carry trades, but there could be dip-buying opportunities in the Japanese stock market,” added Matsuzawa.

US equities

Nicholas Colas, co-founder of DataTrek Research, said in a report that more equity market volatility is expected this week. Colas added that Jerome Powell, chair of the US Federal Reserve, almost certainly knew that the jobs report on 2 August would be weak when he spoke at his press conference on 31 July.

“Markets know this, which is why the report hit stocks so hard. Powell is executing a low-grade version of Paul Volcker’s old playbook: central banks only have credibility when they show themselves to be unafraid of recession to tame inflation,” Colas said. “On the bright side, suddenly lower long-term rates will support the US economy.”

History since 2021 shows that the CBOE VIX Index needs to close at 27 – 35 before we start looking for a tradable or investable low.$SPY pic.twitter.com/sakaSaw0v0

— Nick Colas & Jessica Rabe (DataTrek) (@DataTrekMB) August 5, 2024

July’s 4.3% unemployment rate is higher than anything in the FOMC’s last set of economic projections. Markets expect at least one 50 bps rate cut this year.$SPY

— Nick Colas & Jessica Rabe (DataTrek) (@DataTrekMB) August 5, 2024

Colas added that the increase in unemployment to 4.3% triggered the Sahm Rule Recession Indicator., the difference between the latest three-month average jobless rate and the lows over the last 12 months. “Friday’s reading was 0.53, just above the 0.5 level where history shows a recession is coming,” he said.

2/2 …The Advanced reading for Q2 GDP came in at 2.8%, an acceleration from Q1’s 1.4%. Also, the US economy has not experienced an exogenous shock in the last month, as was the case in every recession since 1973.

— Nick Colas & Jessica Rabe (DataTrek) (@DataTrekMB) August 5, 2024

However, Colas noted that Dr. Sahm has said “it might be different this time”, and the chart above shows why she is cautious on calling a recession. In every past instance, readings of +0.5 have come when the US economy is already shrinking according to Colas.

“The US economy has not experienced an exogenous shock in the last month, as was the case in every recession since 1973,” said Colas. “Therefore, the triggering of the Sahm Rule may be due to the abnormally low levels of unemployment over the last 12 months rather than an unfolding downturn.”