Yen jumped because Japanese central bank raised interest rate from abt 0 to 0.25% and this caused unraveling of pretty massive carry trade.
Carry trade is borrowing money at low interest rate (yen) and converting it into safe money yielding more (dollar). This is not as trivial as borrowing at 0% and investing at 5%, you also need to construct hedges against currency moves (to a certain point), so the profit margin can be low.
While 0.2% was a small change, a lot of funds who borrowed yen and converted into dollars started losing money. They wanted to close some trades so needed to buy yen (since they borrowed in yen and have to repay in yen to close the loan). This made yen rise and positions of more funds (who now have to repay more dollars to close yen loans) even more unprofitable as their currency hedges become very expensive. So more funds wanted to close carry trade positions. And so on.
This is not the only process that drove yen up, but it's a significant one.
- Interest rates up is a market reflection of more scarce capital
- more competition for capital leads to cheaper shares (hence the lower share price)
- and larger desire for foreign investment / less capital outflow to higher yielding / more capital scarce markets
- less capital outflow means fewer yen going out to be transacted for foreign currency (lower forex yen supply) and more investment going into the economy (higher forex yen demand)
- lower supply, higher demand, holding dollar steady (partial equilibrium) leads to higher yen relative to dollar
The BoJ chairman said in the Q&A afterwards that he sees them raising rates above 0.5%, possibly by year end.
The BoJ is also cutting back on the number of government bonds they're buying by half, from 6 trillion yen to 3 trillion yen each quarter.
The yen strengthened a lot in the past 2 weeks, from $1 / 160yen to $1 / 143 yen. This likely triggered a lot of margin calls, exacerbating the drop.
Basically, it was an aggressive and unexpected move.
> If Ueda's goal was to change his dovish image, he was clearly successful. "He sounded very hawkish today," said Hideo Kumano, chief economist at the Dai-ichi Life Research Institute. "He has made the market think more rate hikes are on the way."
> Only 26% of market players expected a rate rise, according to a survey of 181 bond investors conducted by Nikkei affiliate QUICK on July 23-25. Most investors expected a rate increase to take place either in September or October.
