What’s Going On In Japan’s Financial System?

An Unexpected Rate Hike

Japan has long been known for ultra low interest rates, stubbornly low inflation, and a weak yen versus the dollar. But a lot of that has changed recently.

The Bank of Japan (BOJ) raised its benchmark interest rate at the end of July, a move that sent ripple effects through global markets.

Reviewing Trading Strategies

The long-running easy money policies of the BOJ led to investors favoring a particular type of trading strategy: the carry trade. By borrowing in Japan, where interest rates were ultra low, and then investing in U.S. securities, such as U.S. Treasuries, or stocks, investors could reap the benefits of both worlds. But with the BOJ’s rate hike the math behind the carry trade changed.

After the announcement, some of these trades were seemingly unwound, contributing to volatility in Japan’s stock exchange and others. The Nikkei 225, Japan’s main stock index, logged its worst day since the 1987 Black Monday crash. U.S. markets, grappling with their own news cycle, also experienced severe turbulence.

More Volatility?

The BOJ’s decision to raise rates received a divided response from economists. Some view it as a necessary step to end the nation’s easy money policy, while others believe it’s a misstep influenced by political pressure to strengthen the yen, according to a Bloomberg report.

At the initial announcement, BOJ Governor Kazuo Ueda left the door open for additional rate hikes. But Deputy Governor Shinichi Uchida has since tried to calm global financial markets, saying “the bank will not raise its policy interest rate when financial and capital markets are unstable,” as reported in WSJ.

The BOJ’s move is part of a global trend of central bankers making moves to grapple with uncertain global economic conditions. The Bank of England and the Bank of Canada recently cut interest rates, and the Federal Reserve is expected to follow suit in September. Following the turbulence of the past days, some market watchers even suggested the possibility of an emergency Fed rate cut, though the view is far from unanimous.

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