The global market rally picked up the pace on Wednesday with European equities climbing after Japanese stocks recorded strong overnight gains.
The FTSE 100 was up 0.87 per cent at 8,096.26 while the midcap FTSE 250 gained 0.89 per cent to trade at 20,548.25. The CAC in Paris gained 1.6 per cent while the DAX in Frankfurt rose 1.2 per cent.
Gains on the blue-chip index were led by housebuilders and banks while two-thirds of stocks on the midcap index were in the green.
Early gains in Europe came after a strong rebound in Japan, which was the worst hit market in Monday’s massive sell-off.
The Nikkei 225 closed 1.2 per cent higher while the broader Topix index gained 2.3 per cent, meaning Japanese equities are now flat in the week.
The rally in Japan came after the Bank of Japan’s Deputy Governor, Shinichi Uchida, suggested that there would not be any further rate hikes while markets were so volatile.
“As for the future conduct of monetary policy, in a nutshell, I believe that the Bank needs to maintain monetary easing with the current policy interest rate for the time being, with developments in financial and capital markets at home and abroad being extremely volatile,” he said.
On the back of his comments the yen fell more than two per cent against the dollar, having appreciated significantly on the back of last week’s interest rate hike.
A stronger yen has been one of the main drivers of market instability, because it makes the so-called yen carry trade – where investors borrow cheaply in yen to invest in higher yielding assets elsewhere in the world – less profitable.
Many analysts think this has had a major effect in compounding uncertainty after last week’s negative US data releases.
“Fingers are increasingly being pointed at the unwinding of the yen ‘carry’ trade, for amplifying the reaction to a couple of weak US economic data points last week,” Derren Nathan, head of equity research at Hargreaves Lansdown said.
A stronger yen also puts many large Japanese firms, which are big exporters, under some earnings pressure.
Looking ahead, Nathan was not convinced that markets were in the clear. “Given the size of the positions taken (in the carry trade), there could be more volatility to come,” he said.
Thomas Mathews, head of Asia-Pacific markets at Capital Economics, thought the yen would likely rise further in coming months, making the carry trade less and less profitable.
Although markets had essentially priced in further rate hikes from the Bank of Japan, Mathews said the “best candidate” for another major rally would be “concrete news” of a US recession or a significant slowdown.
Even without a big downturn in the US, Mathews thought the yen could rally given the narrowing yield gap on US and Japanese 10-year bonds. This should make the yen relatively more attractive.
Mohit Kumar, an analyst at Jefferies, argued that markets “overreacted” to US data but still thought there could be further risks ahead.
“It is also difficult to ascertain whether the carry trade unwinds are done. Most likely they are not as it was a crowded trade, and it is possible that there are still stress points out there that could result in volatility,” he said.