TOKYO -- Japan's benchmark Nikkei Stock Average fell sharply on Monday after indications that the U.S. Federal Reserve could move away from ultra-easy monetary policies sooner than expected.
The Nikkei index dropped over 1,100 points, or 4%, at one point to its lowest level since May 17, before closing the day down 3.3%. The benchmark recorded the biggest percentage drop in nearly four months, with shares in 96% of the index's 225 companies trading lower. The broader Topix index closed down 2.4% while the startup-heavy Mothers market fell 1.8%.
Some market participants are suggesting that the sell-off is a sign that the so-called "reflation trade" -- picking investments likely to benefit from economic growth and rising inflation -- is starting to unravel. The idea gained momentum last year after progress in COVID-19 vaccine developments. Japan's stock market, with many cyclical stocks was a beneficiary. In February the Nikkei touched its highest level in more than 30 years.
"Some investors are concerned that the U.S. policy change will affect Japan's stock market negatively," said Tomoichiro Kubota, a senior market analyst at Matsui Securities in Tokyo.
Tokyo's fall tracks a retreat by Wall Street's main indexes last week, with the Dow Jones Industrial Average declining over 500 points, or 1.6%, on Friday.
Japan's market sell-off was worse than in other Asian markets. Hong Kong's Hang Seng was down about 1% on Monday morning while South Korea's and Taiwan's benchmarks were down about 1.2%. China's Shanghai Composite index was flat. Australia's index was trading 2% lower.
One Hong Kong equities trader told Nikkei Asia that money was flowing into the U.S. dollar and longer-dated U.S. government bonds, as well as into oil. The WTI crude price has this month reached its highest level since late in 2018.
The sell-off in stocks accelerated after remarks from St. Louis Federal Reserve President James Bullard on Friday that an initial rate increase could happen in late 2022 as inflation risks rise.
Forecasts from the Federal Open Market Committee earlier last week suggested that its first post-pandemic interest rate hike could come in 2023. In March, the Fed had signaled there would be no rate increase until at least 2024.
"There are varying outlooks about the U.S. rate hike. For some, suggestions of 2022 came as a surprise," said Keita Kubota, head of Japanese equities at Neuberger Berman in Tokyo.
"Japan's stock market is declining the most as it has the most liquidity in Asia," he said. "Today is somewhat an overreaction. I think this sharp decline won't last long."
Uniqlo owner Fast Retailing dropped more than 4%. SoftBank Group ended down 3.5%, hitting its lowest level since December.
Some investors are concerned that an earlier rate increase could hinder the U.S. economy's recovery from the pandemic. As a result, shares in Japanese exporters set to benefit from rebounding economic growth, like auto companies and chemical firms, also fell sharply. Shares in Suzuki Motor dropped 4.6%.
Semiconductor-related companies also took a hit, with shares in Tokyo Electron, Advantest and Renesas Electronics all dropping more than 3%. Shares in Shin-Etsu Chemical, a maker of silicon wafers, fell 5.7%.
Kerry Craig, global market strategist at J.P. Morgan Asset Management, said: "We believe that market jitters over the latest Federal Reserve meeting will pass, as inflation appears to be mostly transitory and the growth outlook continues to be positive. The ongoing recovery in Europe is adding muscle to the global growth story, leading us to favor more cyclical markets."
Emerging markets and Asia equities could be "somewhat marginalized" in the short term by the strength of the US dollar and COVID cases, Craig said, "but vaccination rates are picking up and corporate earnings remain robust."
John Paul Lech, who manages emerging markets equity strategy at Matthews Asia, said: "As inflation fears dampen in the second half of 2021 and U.S. rates stabilize, we expect Asian and emerging markets risk assets to revert back to fundamentals, reflecting a strong earnings rebound expected in the 2021-22 period."