Global Markets on Edge as Bank of Japan Eyes Historic Rate Hike
Robust wage growth fuels bets on a December policy shift, threatening to unwind the decade-long yen carry trade and inject volatility into US equities.
Global financial markets are holding their breath this week ahead of a pivotal Bank of Japan (BOJ) policy meeting on December 18-19, where the central bank is widely expected to end its era of negative interest rates with a landmark rate hike.
Fueled by the strongest wage growth in three months, market participants are pricing in a 90-95% probability of a 25-basis-point rate increase, according to forecasts on FXEmpire. Such a move would lift the policy rate from negative territory to 0.75% and mark a historic turning point for a country that has spent decades battling deflation with ultra-loose monetary policy.
The catalyst for this anticipated shift is a string of encouraging economic data, most notably Japan's nominal wage growth, which accelerated to 2.6% year-over-year in October. For BOJ officials, sustained wage momentum is the final piece of the puzzle, providing confidence that Japan can maintain its target of 2% inflation.
The implications of this policy pivot extend far beyond Tokyo. A rate hike from the BOJ could trigger a significant unwinding of the 'yen carry trade,' a popular global investment strategy. For years, investors have borrowed yen at near-zero interest rates to fund investments in higher-yielding assets abroad, including US stocks and bonds. An interest rate increase makes the yen more expensive to borrow, prompting investors to sell those foreign assets to buy back yen and repay their loans.
While some analysts believe a "brutal" unwind is not the base case, a hawkish move from the BOJ could still introduce significant turbulence. "Wage strength reinforces BOJ hike odds," notes one analysis, leading to a strengthening yen as the carry trade dynamics shift. The currency has already responded, with the USD/JPY pair sliding below the 156 level as anticipation builds.
This tightening in Japan starkly contrasts with the policy direction in the United States. The US Federal Reserve is expected to continue its monetary easing, with markets forecasting potential rate cuts in 2026. This policy divergence—the BOJ tightening while the Fed is loosening—narrows the interest rate differential that made the yen carry trade so attractive, further pressuring investors to repatriate capital.
As the BOJ's two-day meeting approaches, traders are on high alert. While a rate hike is largely priced in, the key variable will be the central bank's accompanying commentary and its outlook for policy in 2026. Any signals of a more aggressive tightening cycle could accelerate the carry trade unwind, posing a headwind for global equities already contending with rich valuations.