Japan’s Nikkei touches bear market territory. What’s next?

Japan’s Nikkei touches bear market territory

Japanese equities look set to extend its losing streak to the fourth straight day in today’s session, as the Nikkei is poised to enter bear market territory, which is defined as a 20% pullback from recent highs. The index is down as much as 8% today, with intermittent attempts from dip buyers to pare some losses mid-day failing to materialise.

Strength in Japanese yen keeps the downward pressures going

Japanese equities have been sensitive to the strengthening of the yen, which one may argue that we will need to see some form of stabilisation in the currency to halt the outflows in equities. A rapid strengthening in the yen has brewed market jitters around Japanese exporters, which has been enjoying an overseas income boost from a weaker currency over the past years and has been a key driver for the stock market performance.

The tide is now reversing, with the yen up more than 10% against the greenback since mid-July, punching through several key trendline support on strong volume. Extreme positioning in the short-yen trades may magnify any upside moves in the currency amid aggressive short-covering. A look at the latest speculative yen positioning (from Commodity Futures Trading Commission data) suggests that while there has been a significant unwinding, speculative traders remain in net-short territory, which seems to leave room for further repositioning.

Market pricing for further rate hike by the end of the year

The broad market expectations are that we may see another 10 basis point (bp) hike from the Bank of Japan (BoJ) either in the October or December meeting. A hawkish guidance from Japanese policymakers at the recent BoJ' meeting has been the trigger, with the BoJ Governor mentioning that if economic conditions move in line or overshoot their forecasts, the central bank will be inclined to raise interest rates further.

That said, given the hefty sell-off in the Japanese markets lately, policymakers may be more inclined to tread carefully from now on, potentially guiding for a more wait-and-see approach with considerations for the negative wealth effect on households and corporate financing costs.

Federal Reserve behind the curve? US ISM services PMI on close watch

Weaker-than-expected US economic data has also spurred a broader risk-off mood across global markets, with calls for a more aggressive rate easing process from the US Federal Reserve (Fed) to limit recession risks. A 50 basis point cut in September is now the market consensus.

Whether risk sentiments can stabilise near-term may revolve around the US Institute for Supply Management (ISM) services Purchasing Managers' Index (PMI) release later today. Expectations are for US July services activities to revert to expansionary territory at 51.0 from the 48.8 prior, which may offer some calm to US growth jitters if it materialises.

The data will be crucial, given that the Nasdaq 100 index is on track to retest its 200-day moving average (MA), which could offer a make-or-break moment for US equities and the broader risk environment ahead.

Nikkei 225: Key trendline breakdown in focus

A key upward trendline for the Nikkei 225 index has caved in last week, which suggests sellers in broad control, as its daily relative strength index (RSI) heads further below the mid-line and its daily moving average convergence/divergence (MACD) registers its lowest level since March 2020.

Amid near-term extreme oversold technical conditions, dip buyers are attempting to defend the 33,250 level in today’s session, which may mark a level of projection from its double-top formation breakdown earlier last week.

That said, any attempt to bounce may face heavy resistance at the 35,000 level, where the upward trendline may now serve as resistance to overcome. On the downside, any failure for the 33,800 level to hold may potentially pave the way towards the next immediate support at the 31,700 level next.