BOJ Signals Rate Hike, Threatening Yen Carry Trade Fueling US Stocks
A potential December policy shift from the Bank of Japan raises concerns of a multi-billion dollar unwind of cheap yen-funded trades that have buoyed global equities.
A hawkish shift from the Bank of Japan is sending ripples across global financial markets, as investors brace for a potential December interest rate hike that could dismantle one of the most popular trading strategies of the post-crisis era: the yen carry trade.
For years, global investors have borrowed cheaply in Japanese yen, benefiting from the country's ultra-low interest rate policy, to purchase higher-yielding assets abroad, particularly U.S. stocks. This flow of capital has been a key source of liquidity supporting Wall Street. Now, signs that the BOJ is preparing to tighten policy threaten to trigger a rapid and potentially disorderly unwind of these positions, forcing investors to sell U.S. assets to repay their strengthening yen-denominated loans.
The market has already witnessed a preview of the potential fallout. A surprise 25-basis-point rate increase by the BOJ in August 2024, which brought the benchmark rate from 0.1% to 0.25%, was followed by a sharp sell-off in U.S. stocks. The Dow Jones Industrial Average plunged over 1,000 points and the Nasdaq Composite fell 3.4% in the sessions that followed, a reaction many analysts attributed to an initial unwinding of carry trades, according to analysis from Seeking Alpha.
"A BOJ hike is the event that could finally break the yen carry trade," noted a recent report from investment research firm Amundi. The sheer scale of the carry trade, estimated to be in the hundreds of billions of dollars, means even a partial unwind could introduce significant selling pressure into U.S. equity markets.
Currently, swaps markets are pricing the likelihood of a December rate hike as a near "coin toss," reflecting deep uncertainty over the central bank's timing. Investors are now parsing every word from BOJ officials for clues. A key speech by Governor Kazuo Ueda scheduled for December 1st and the release of the bank's 'Summary of Opinions' from its October meeting are seen as critical events that could provide clearer guidance.
Driving the BOJ's calculus is Japan's domestic inflation, which has remained above the bank's 2% target, and a desire to normalize policy after decades of extraordinary stimulus. However, the bank must also weigh the risks of hiking too soon, especially as real wages in Japan continue to shrink, a factor that could dampen consumer spending and economic growth, as highlighted by Forex.com.
As the Federal Reserve contemplates potential rate cuts in the coming year, the policy divergence that has made the yen carry trade so profitable is set to narrow. This fundamental shift ensures that the Bank of Japan's next move will not just be a local affair but a global market event, with the stability of U.S. stock performance hanging in the balance.