Japan's Interest Rate Hike Imminent... Will Global Financial Markets Shake Again?

As the expectation grows that the Bank of Japan (BOJ) will raise its benchmark interest rate this month, fears of unwinding yen carry trades are spreading again in the market. There is concern that another 'Black Monday' could occur, similar to last year when Japan's interest rate hike coincided with signs of a U.S. economic slowdown, causing global financial markets to shake. The market is closely watching the BOJ amid policy uncertainty due to the inauguration of U.S. President-elect Donald Trump.

Interest Rate Hike After 6 Months?

According to the Nihon Keizai Shimbun on the 19th, more than half of the nine policy board members who decide the BOJ's benchmark interest rate are expected to favor an additional rate hike at the monetary policy meeting scheduled for the 23rd-24th. The Nihon Keizai Shimbun observed that a final decision will be made after watching the remarks of President-elect Trump, who will be inaugurated on the 20th, and the subsequent market reactions.

If the BOJ opts for a rate hike, the benchmark interest rate will become 0.5% per annum. This would be the third hike since the decision to raise the rate to 0.25% per annum at the meeting last July, and since the negative interest rate was lifted in March last year. The 0.5% level is the first since February 2007 to October 2008.

The BOJ's policy board, which decides on monetary policy, consists of nine members, including Governor Kazuo Ueda, Deputy Governor Shinichi Uchida, and Deputy Governor Ryozo Himino. Decisions are made by majority vote, and if five or more members agree, it is passed. The Nihon Keizai Shimbun predicted that although some policy board members are cautious, there is a high possibility that a rate hike will be decided.

According to Reuters, until last month, experts were divided on whether the BOJ would raise the rate to 0.5% in January or March. However, since the beginning of this month, the opinion favoring a January hike has become dominant. Governor Kazuo Ueda, who is also a policy board member, stated on the 15th and 16th that they would discuss and decide whether to implement a rate hike at the meeting, and Deputy Governor Ryozo Himino made similar remarks on the 14th.

Takeshi Yamaguchi, chief economist at Morgan Stanley MUFG Securities, expressed in a report on the 16th that a January rate hike is almost a done deal. The Overnight Index Swap (OIS) market sees an 80% probability of an additional rate hike this month.

Will Yen Carry Unwinding Repeat?

With the prospect of an imminent rate hike, concerns have grown in the market about the unwinding of 'yen carry trades.' The interest rate differential between the U.S. and Japan acts as an incentive for yen carry trades, where the low-interest yen is borrowed or sold to invest in high-interest currencies or high-yield assets. If the U.S.-Japan interest rate differential narrows, the possibility of yen carry unwinding increases.

At the end of July last year, the BOJ's interest rate hike and the deterioration of U.S. employment statistics coincided, leading to an expansion of yen carry unwinding, which resulted in a stock market crash and triggered 'Black Monday' on August 5th. The Bank of Korea analyzed last September that the total balance of yen carry trades was 506 trillion yen, with 32.7 trillion yen being funds with a high possibility of unwinding.

Recently, the yen-dollar exchange rate has turned to a downward trend (yen appreciation). Last week (13th-17th), the yen-dollar exchange rate fell to 154 yen per dollar at one point, marking the highest level of yen appreciation in the past month. This was also a movement due to the BOJ's interest rate hike outlook. According to the Nihon Keizai Shimbun, Mizuho Securities predicted that if the benchmark interest rate is raised this month, the exchange rate could fall to 153 yen.

Bank of America pointed out that stronger-than-expected yen appreciation this year could burden U.S. growth stocks, stating to Nikkei that if Japan's economic recovery strengthens and the BOJ seriously proceeds with rate hikes, it could lead to forced unwinding of carry trades.

Trump's Inauguration as a Variable

However, some analysts believe that the current situation is different from last summer, making it difficult to see a repeat of financial market turmoil. The U.S. labor market is showing a robust appearance, and concerns about a U.S. economic slowdown have been dispelled. The variable is the inauguration of President-elect Trump and the resulting policy changes.

Masamichi Adachi, an economist at UBS, told Reuters that if the financial market plummets to panic levels after Trump's inauguration, the BOJ might not proceed with a rate hike, but he assumes there will be no major shock after the inauguration on the 20th. UBS expects the BOJ to raise rates again in July and December.

On the 17th, the Nikkei index closed at 38,451.46, down 0.31%. During the day, the decline exceeded 1.3%. It is interpreted that the selling pressure spread in anticipation of increased volatility ahead of Trump's inauguration on the 20th and the BOJ's rate decision on the 24th.

Han Kyung-jae hankyung@hankyung.com