The Truth Behind Japan's "Interest Rate Hikes": A Misunderstood Financial Shift
Hello everyone, I'm your financial analyst. Recently, the Japanese financial market has been quite volatile, with the yen's exchange rate fluctuating and government bond yields soaring. There are rumors that the Bank of Japan (BOJ) is about to significantly raise interest rates. Many believe this marks a turning point for Japan as it moves away from the "zero-interest-rate" era and towards "normalization," which could potentially trigger a major reshuffle of global assets.
In my view, it's like a patient with a fever. The doctor focuses only on the fever reducer (interest rates) but ignores the underlying weakness caused by long-term malnutrition (insufficient money supply). If we only treat the fever without addressing the underlying issue, the patient could actually become even more ill.
Today, we'll break down this situation in simple terms to understand the logic behind it and its implications for us as individuals and the global market.
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Misconception 1: Confusing "turning off the tap" with "turning on the tap"
First, we need to correct a major misconception: Raising interest rates does not necessarily mean the economy is getting better, nor does it mean the monetary environment is becoming more relaxed.
The current market logic is: BOJ raises interest rates → Yen interest rates increase → People prefer to hold yen → Yen appreciates → Economy "normalizes."
There's a huge flaw in this logic.
We need to look at a more fundamental indicator: Money Supply (M2). Think of money supply as the "total amount of blood" in the economy.
- Current situation: As of August 2026, Japan's M2 growth rate is only around 2.0%.
- Target: To maintain 2% inflation and moderate economic growth, the money supply growth rate should typically be between 5% and 6%.
It's like a car trying to speed up; you need to step on the gas (raise interest rates) more, but the tank (money supply) is only enough for a short distance. If you keep stepping on the gas too hard, the car might not only fail to speed up but may even stall (due to tighter credit).
Since the 1991 bubble burst, Japan's biggest problem has not been "too low interest rates" but rather "not enough money." Despite years of quantitative easing (QE), much of the money created has remained in the banking system without flowing into the real economy and causing effective monetary expansion.
Therefore, if the current interest rate hikes suppress banks' willingness to lend, they will only reduce the already insufficient money supply growth rate. This is not normalization; it's applying the wrong remedy. True normalization would involve bringing the money supply growth rate back to 5%-6%, not just raising interest rates.
Yen Exchange Rate: A "Real Reversal" or a "Feint"?
The yen has risen from 164 to 153 recently, and many are cheering that the yen is getting stronger. However, I think this is more short-term noise rather than a long-term trend.
Why?
1. Fundamentals remain unchanged: As mentioned earlier, Japan's money supply is still insufficient. Historically, when the monetary environment is tight, the yen tends to weaken. The current strength of the yen is mainly due to expectations (that the BOJ will raise rates) and external factors (such as the U.S. Treasury buying yen).
2. Limited external support: The U.S. Treasury has indeed intervened, but this is just a temporary fix. Unless there's large-scale multilateral coordination like during the Plaza Accord in the 1980s, it's difficult to change the underlying fundamentals just through occasional interventions by two central banks.
3. Future risks: If future rate hikes suppress credit and further reduce the money supply growth rate, the yen's strength could quickly turn into weakness.
In summary: The current rise in the yen is like being sustained by stimulants, not by a strong economic foundation. Once the stimulants wear off or the money supply continues to deteriorate, the exchange rate could face new pressures.
Global Arbitrage Trading: Don't Worry About a "Crisis," but Expect a Gradual Adjustment
Many fear that Japan's rate hikes and yen appreciation will lead to a massive unwind of carry trades and a global stock market crash. This concern is somewhat exaggerated. Let's look at the interest rate differential:
- Japan's interest rates: Even if they rise to 1.25% or 2% in the future.
- U.S./Euro interest rates: They are already high, and major central banks around the world are also raising rates.
The key point is: As long as U.S. and Euro interest rates remain significantly higher than Japan's, the large interest rate differential will persist.
- Borrowing yen (at 1.25%) to invest in U.S. assets (returning 4%-5%) still yields a 2%-3% risk-free profit.
- This profit margin is still attractive.
Therefore, a large-scale, panicked unwinding of carry trades is unlikely. More likely, there will be a gradual adjustment:
- High-saving individuals in Japan will continue to invest abroad (since domestic yields are lower).
- Arbitrage funds will gradually decrease, not disappear suddenly.
Implication for individuals: Don't expect global asset prices to plummet overnight due to Japan's rate hikes. This is a slow, structural reallocation of funds.
The U.S. Treasury's "Magical Moves": Helping or Harming the Market?
U.S. Treasury Secretary Yellen has been quite active, publicly supporting a stronger yen and increasing the scale of U.S. bond purchases to stabilize yields. She even claims to be the "market maker."
This sounds powerful, but there are two major risks:
1. Embarrassing intervention in foreign currencies: Why should U.S. taxpayers pay to buy yen? If the intervention fails and the yen falls, the money is wasted, and it increases fiscal costs.
2. Distorting the U.S. bond market: The Treasury is lowering long-term interest rates by buying long-term bonds and issuing short-term ones. This masks real inflation and credit demand pressures.
- Consequences: Long-term interest rates are artificially suppressed, hiding the true cost of inflation.
- Hidden danger: 35% of U.S. personal income taxes are currently used to pay interest! If this manipulation continues, any market shocks could lead to a surge in debt service costs.
In short: The Treasury is using "financial tricks" to hide fiscal deficits and inflation. Tricks will eventually be exposed.
The Real Drivers: AI Investment and the Global Debt Crisis
Finally, let's look at the bigger picture. Why are global yields rising? Besides Japan, there are two more fundamental reasons:
1. The AI-driven credit boom: Building data centers and developing AI requires massive amounts of capital, mostly borrowed.
- Banks lend this money, creating new money (deposits) and increasing the money supply, which raises interest rates.
- This is a hidden cost: AI investment not only consumes funds but also drives up the overall cost of financing through credit expansion.
2. Narrowing fiscal space: Governments in Japan, Europe, and the U.S. face significant spending challenges; cutting spending is difficult (political resistance), and raising taxes is hard (economic weakness).
- Debt is accumulating, and interest rates are rising, becoming a major portion of fiscal expenditures.
- This creates a vicious cycle: More borrowing to pay interest, and higher borrowing leads to even higher interest rates.
Conclusion and Outlook:
- For Japan: Focus on money supply (M2) rather than just interest rates. If M2 growth doesn't improve, so-called normalization is an illusion, and the yen and bond markets will continue to fluctuate.
- For the global market: Arbitrage trades won't collapse, but there will be gradual adjustments.
- For the U.S.: The Treasury's intervention is delaying the pain, not solving it. AI-driven credit expansion is the hidden driver of rising interest rates.
Advice for investors:
Don't blindly believe in the simplistic notion that Japan's rate hikes mean the end of a global bull market or a sudden surge in the yen. The real risks lie in rising global debt costs and changes in the money supply structure. Pay attention to industries sensitive to interest rates and those heavily leveraged, and be cautious about the long-term uncertainties stemming from U.S. fiscal sustainability.
In this complex situation, money supply is the most reliable and fundamental indicator. Interest rates are just the surface; money is the real driver.