Yen's New Direction: How Japan's Interest Rate U-Turn is Shaking Global Markets

Changes in the Bank of Japan's Interest Rate Policy and Its Impact

The Bank of Japan has recently raised its benchmark interest rate consecutively. In March 2023, it raised the negative interest rate that had been in place for 12 years to 0-0.1%, and at the end of July, it further increased it to 0.25%. Let's examine the background of these policy changes and their impact.

Background of the Negative Interest Rate Policy

Japan has maintained a negative interest rate policy to combat chronic deflation. This means that instead of paying interest on bank deposits, depositors have to pay fees. For example, at a -1% interest rate, a 100 yen deposit would become 99 yen after a year. Through this, Japanese authorities aimed to encourage people to choose consumption or investment over savings, promoting economic growth.

Reasons for Interest Rate Hikes

The recent interest rate hikes are measures to respond to the deepening weakness of the yen and inflationary pressures. As Japan's inflation rate has risen, the central bank seems to have judged it's time to end the abnormal negative interest rate policy and normalize monetary policy.

Problems with the Weak Yen

The weak yen has led to an increase in import prices, especially for raw materials and grains, accelerating inflation. This has resulted in price increases outpacing wage growth, causing a decrease in real income and contraction in household consumption, ultimately hindering Japan's GDP growth.

Purpose and Side Effects of Interest Rate Hikes

The Bank of Japan aims to curb the yen's weakness and stimulate consumption through interest rate hikes to recover economic growth rates. However, this policy could have side effects such as weakening the competitiveness of Japanese export companies and increasing the burden on households and businesses due to rising mortgage rates.

Impact on Global Financial Markets

1. Changes in Hedge Fund Strategies: Impact on Yen Short, Japanese Company Long Strategies Until now, global hedge funds have adopted yen short and Japanese company long strategies due to the weak yen and the resulting improvement in Japanese export companies' performance. These strategies are now taking a hit.

2. Reduction in Yen Carry Trade: Decline in US Big Tech Stocks and Emerging Market Indices As the yen carry trade - borrowing cheap yen at low interest rates to invest in US or other emerging financial markets for profit - shrinks, US big tech stocks are falling, and Asian and other emerging market indices are declining along with them.

3. Repatriation of Japan's Overseas Investment Funds: Downward Pressure on US Treasury Prices and US Stock Market Japan's investments in global financial markets amount to trillions of dollars. As the interest rate gap between the US Fed benchmark rate and the Bank of Japan narrows, there's a trend of Japanese overseas investment funds returning home. This is also becoming another factor causing a decline in US Treasury prices and the US stock market in the global financial market.

Conclusion

In the current situation where the US Federal Reserve's interest rate cut outlook and the Bank of Japan's interest rate hike trend are intertwined, it's necessary to keep a close eye on how the monetary policy directions of both countries will affect the global financial market.