How could Japan shake
up the global markets?
Minutes from the Bank
of Japan’s October meeting point to another rate hike in December, and it’s
easy to see why.
The weak yen and
rising energy costs driven by Middle East tensions have pushed core inflation
to 2.1% year over year in September, its highest level since early 2026 and
above the BOJ’s 2% target, while the measure excluding food and energy climbed
to 2.4%. Higher oil prices add to these inflationary pressures, particularly because
Japan relies heavily on energy imports. This also makes oil prices an important
factor to watch when assessing the BOJ’s next policy move.
As for why the BOJ is
holding back, even though the conditions for a hike are already in place, a
tighter policy could help bring inflation under control and ease pressure on
the yen, but it would also make borrowing more expensive, potentially cooling business
activity and investment.
Another reason is Japan’s massive
government debt, which exceeds 200% of GDP. Rather than paying it off, the
government keeps rolling over maturing bonds by issuing new ones, while
continuing to pay interest on its debt.
This means that higher
rates would make that debt increasingly expensive to service, putting even more
pressure on public finances and raising concerns about long-term debt
sustainability.
Currency intervention
could also help ease some of this pressure. By selling US dollars and buying
yen, Japan’s authorities can support the currency and curb imported inflation.
Such intervention could also trigger a sharp move lower in USD/JPY,
depending on its scale and how markets interpret the authorities’ intentions.
The yen they receive can then be withdrawn from circulation, reducing liquidity
in the economy.
The catch is that
Japan’s reserves, while substantial, are not unlimited. And a large part of
them is held in US Treasuries.
If Japan starts
selling those bonds to support the yen rather than hiking rates, Treasury
yields could climb, putting pressure on global markets, particularly riskier
assets. After all, why take risks in stocks when you can earn a relatively safe
5% on government bonds?
A Fed rate cut could
offer relief to both US and Japanese markets by making the yen carry trade less
attractive, but with inflation still running hot and the labor market holding
up, that looks unlikely for now.
On the other hand, if
the Fed does move in the opposite directionto BOJ and the carry trade unwinds,
it could create another problem: investors who borrowed yen to buy foreign
assets may be forced to sell them to repay their loans. This could trigger a repeat
of the 2024 sell-off across markets.
