The Bank of Japan is paving the way for an interest rate hike. Recently, Bank of Japan Governor Kazuo Ueda, in a speech, unusually mentioned the upcoming monetary policy meeting in December, stating that a decision would be made "as appropriate" at that time.
This statement was seen as a strong signal, instantly igniting market expectations for a Bank of Japan interest rate hike this month. As a result, Japanese government bond yields rose across the board, the yen appreciated against the dollar, and Japanese stocks closed lower.
The Bank of Japan's hawkish stance has raised concerns that a rate hike could trigger a reversal in yen carry trades, leading to significant volatility in global markets. However, most respondents believe that given the current reduction in carry trade positions and the partial priced-in of rate hike expectations, the spillover effects of this round of carry trades on global markets are expected to be manageable.
Expectations for a Bank of Japan rate hike in December are rising.
On December 1st, Bank of Japan Governor Kazuo Ueda delivered a speech in Nagoya, releasing a clearly hawkish signal. He stated that the Bank of Japan will weigh the pros and cons of raising policy rates and make a timely decision based on a review of domestic and international economic, inflation, and financial market conditions. If economic and inflation forecasts are met as expected, the Bank of Japan will continue to raise policy rates at its December policy meeting, depending on the improvement in the economy.
The market interpreted the above statement as the clearest signal of an interest rate hike to date, increasing expectations for a December rate hike by the Bank of Japan. According to the US forecasting platform Polymarket, the market's current bet on a 25 basis point rate hike by the Bank of Japan in December has surged from 50% to 85%.
"Given the relatively clear policy signals released in the Bank of Japan governor's speech, the likelihood of a December rate hike by the Bank of Japan has increased significantly." - Zheshang Securities Lin Chengwei, chief macro analyst, told Shanghai Securities The reporter stated.
Despite strong signals of an interest rate hike, Kazuo Ueda also employed a "balancing act"—attempting to reassure the market and emphasize that any policy adjustments would be gradual, aiming to avoid shocking the economy. Ueda stated, "Raising interest rates under loose monetary conditions is not putting the brakes on economic activity." This indicates that even if interest rate hikes are initiated, Japan's financial environment will remain loose.
The strong signal of an interest rate hike triggered a sell-off in Japanese stocks and bonds. Following Kazuo Ueda's speech, yields on Japanese government bonds across all maturities continued to rise. The yield on the 2-year bond, most sensitive to interest rate policy, reached a high of 1.033%, its highest level since 2008; the yield on the 30-year bond hit a record high, reaching 3.425% as of 4:30 PM on December 2nd. The Nikkei 225 index closed down 1.89% on December 1st, leading the decline in Asian stock markets.
Market analysts believe that multiple factors, including the Japanese government's aggressive fiscal policy, have fueled investor concerns about the sustainability of Japan's fiscal policy. According to the International Monetary Fund (IMF), Japan's government debt ratio (government debt as a percentage of GDP) is projected to reach 229.6% in 2025, the highest among developed economies. If the Bank of Japan were to raise interest rates, it would significantly increase the government's borrowing costs and interest payment pressures.
The yen strengthened against the dollar, rising to 154.66 on December 1st. A previous report from Nomura Securities stated that with rising expectations of a December rate cut by the Federal Reserve and a strengthening expectation of a rate hike by the Bank of Japan, the yen's consolidation pattern around the 156.50 level may be broken, potentially leading to a significant turning point in the yen's trajectory.
The impact of the reversal of yen carry trades may be less than last year.
With the Bank of Japan signaling a hawkish interest rate hike, the market is concerned that the narrowing interest rate differential between the US and Japan could trigger a reversal in yen carry trades, thereby impacting global markets.
For a long period, the Bank of Japan maintained an ultra-loose monetary policy, making the yen a "low-interest currency." Typically, the typical path of yen carry trades is: borrowing low-cost yen, converting it into a high-yield currency, and investing in high-yield assets; then converting the invested currency back into yen at maturity to repay the debt.
However, significant risks lurk behind yen carry trades. On July 31, 2024, the Bank of Japan unexpectedly raised interest rates to 0.25% and announced a gradual reduction in its purchases of Japanese government bonds. This coincided with weak US employment data and rising concerns about an economic recession, with the market anticipating a new round of interest rate cuts by the Federal Reserve. Against this backdrop, large-scale yen carry trades were quickly unwound, considered a major culprit in the sharp fluctuations in global capital markets; the "Black Monday" of August 5th last year is a prime example.
More than a year later, a similar scenario has reappeared. Will a new round of "carry trade unwinding" unfold? What will be the impact on global financial markets?
Based on comprehensive market analysis, the impact of this round of yen carry trade reversal on the market is expected to be less than last year. Lin Chengwei analyzed for reporters that, firstly, the current yen carry trade positions and crowding are lower than before, so even if some carry trades are closed, the impact on the market will not be too great; secondly, the market volatility in July and August last year was a panic trade caused by the combination of the Bank of Japan's interest rate hike and the "false drop" in the Fed's non-farm payroll data. Currently, no such phenomenon has been observed in the US job market, and it is expected that if the Bank of Japan raises interest rates, the market reaction will be relatively mild.
Xu Jiaqi, an analyst at the Research and Development Department of Golden Credit Rating, and Feng Lin, Executive Director of the Research and Development Department of Golden Credit Rating, told the Shanghai Securities News that a rate hike by the Bank of Japan would indeed lead investors to reduce their short positions in the yen, triggering a certain scale of carry trade unwinding. However, the scale of carry trades has already shrunk over the past year. Meanwhile, market expectations for a rate hike by the Bank of Japan have been rising recently, meaning that if the rate hike is in line with expectations, its impact may have already been partially priced in, preventing a disorderly sell-off. If the Bank of Japan raises rates this month, the resulting reversal of carry trades is expected to have a smaller impact on the market than in August last year. However, if the rate hike or subsequent guidance is more aggressive than the market anticipates, or if the fragile year-end liquidity environment amplifies the sell-off effect, it could trigger a short-term stampede and exacerbate volatility in global financial markets.
(Source: Shanghai Securities News)
