The Bank of Japan is expected to raise interest rates as early as quarterly! Be wary of declining “arbitrage trading” to amplify stock and bond fluctuations

The Zhitong Finance App learned that the most important change in current market expectations for the Bank of Japan's monetary policy is that the market is unanimously predicting that the central bank will advance interest rate hikes faster than the recent slow pace of interest rate hikes. All 52 economists in the Bloomberg survey expect to raise interest rates on September 18, and about 93% expect to raise interest rates again by January next year; the proportion of interest rate hikes every quarter is expected to drop from 82% in July to only 6% according to Bloomberg's latest economist survey.

However, the median interest rate forecast for the end of this round of the Bank of Japan's interest rate hike cycle is still around 1.75%. Based on the current policy interest rate of 1% and the calculation of 25 basis points for each rate hike, this means there is still room for three interest rate hikes, including the anticipated September action. For the global stock market, this is an important logic that supports the bullish trajectory of the international stock market outside of Japan in recent years, when the Bank of Japan is raising interest rates ahead of schedule. The pace of interest rate hikes by the Bank of Japan is accelerating across the board, which will significantly raise the Japanese yen carry trade (carry trade) financing costs of “borrowing low-interest yen and investing in high-yield bonds and stock assets from overseas” — and this arbitrage trading model is an important logic that supports the bullish trajectory of international stock markets outside of Japan in recent years.

The clock for interest rate hikes is being set fast, and global stock markets are re-evaluating the cost of yen capital?

Even if interest rates rise to 1.25%, the Bank of Japan expects financial conditions to remain relaxed, and the continuing energy shock is undoubtedly strengthening the urgency of the Bank of Japan's hawkish tone.

Japanese corporate commodity prices rose 7.6% year on year in August, and import prices in yen rose 24.8% year on year, indicating that the increase in fuel prices and the previous depreciation of the yen are still being transmitted to corporate costs. The world's major economies have generally faced wider austerity pressure recently. The ECB announced another 25 basis point rate hike on September 10 to raise deposit interest rates to 2.5%; as of September 11, before the US Consumer Price Index was announced, the probability of the US Federal Reserve's 25 basis point rate hike in September included in the futures market was 71.1%, up from 61.2% in the previous trading session.

Meanwhile, the Houthis have seized the port of Mocha in Yemen and threatened Red Sea shipping. Mutual attacks between the US and Iran also continued to restrict transportation in the Strait of Hormuz. Brent crude oil rose sharply by more than 6% on September 10 to approach the 110 US dollar mark; on September 11, the market reported that a team of diplomats from the Middle East and Gulf countries was trying to negotiate temporary navigation arrangements with Iran. The oil price then fell. As of 06:43 GMT, it was 105.99 US dollars, but the increase during the week was still over 10%. This pattern of “limited supply and repeated negotiations” will raise the central bank's vigilance that energy price increases will continue to spread to the prices of other goods and services. Based on the closing price of 72.48 US dollars for Brent crude oil on February 27, the last trading day before the outbreak of the US-Iran war, the price of Brent crude oil has increased by more than 50% since the war.

Looking at stock investment strategies, the acceleration of interest rate hikes in Japan will simultaneously affect financing, exchange rates, and valuations: rising Japanese yen borrowing costs, if accompanied by a rapid appreciation of yen, may cause some arbitrage transactions to reduce positions and amplify global risk asset fluctuations; rising interest rate expectations in the US and Europe will further suppress AI-themed growth stocks that are overvalued and rely on a long-term profit growth trajectory.

The Bank of Japan's interest rate hike will increase the cost of “borrowing low-interest yen and investing in high-yield assets overseas”; if accompanied by a rapid appreciation of the yen, investors will also face exchange losses to repay yen debts, and leveraged positions may trigger additional security deposits or be forced to close positions as a result. Selling assets such as overseas stocks and buying back Japanese yen debt when closing positions may also further boost yen, forming feedback that exchange rates and asset sell-offs reinforce each other, amplifying global stock market fluctuations.

Therefore, if the Bank of Japan speeds up the pace of interest rate hikes, it will significantly increase the financing costs of yen arbitrage transactions, and may weaken its financial support for risky assets such as overseas stocks; if combined with the rapid appreciation of the yen, it may also increase the pressure of deleveraging.

However, the Bank of Japan's promotion of interest rate hikes will not necessarily trigger a collapse in arbitrage trading. The key is whether the policy path and policy tone have exceeded expectations, how domestic and foreign interest spreads have changed, and how fast the yen appreciates and how crowded leveraged positions are.

The Bank of Japan has the opportunity to benefit from higher loan yields, but it still needs to assess deposit costs, bond valuation losses, and credit risk; exporters are more sensitive to yen appreciation and overseas demand. Since the interest rate hike in September has been widely anticipated, what really affects the subsequent market is more likely to be voting differences, central bank governor Ueda Kazuo's statement on the expected schedule for the next or more interest rate hikes, and whether the final interest rate will rise.

After the September rate hike, interest rates will be raised again by January next year at the latest! From semi-annual steps to a quarterly rhythm, expectations for Japan's interest rate hike have moved forward across the board

Economists agree that the latest compilation of Bloomberg research reports shows that the Bank of Japan will raise the benchmark interest rate next week and raise interest rates again by January next year at the latest, clearly speeding up the process of policy normalization.

According to the survey, all 52 Bank of Japan observers predicted that borrowing costs would rise during the two-day meeting ending September 18. About 93% expect another operation by January next year at the latest, and about one-third of them predict that it may be in December. The rest chose January, and no one predicted that interest rate hikes would start one after another or continuously in October.

As shown in the chart above, Bank of Japan observers agree that interest rates will be raised again in September, and another rate hike in January next year at the latest. Source: Bloomberg's latest survey of 52 Bank of Japan observers.

The survey results reflect a drastic shift in economists' views: in the last survey conducted in July, no one expected policy adjustments in September. The Bank of Japan faces the risk of rising inflation, and US Treasury Secretary Scott Bessent's repeated calls for action have also boosted market expectations for this month's rate hike.

Izuru Kato, chief economist at the Totan Research Institute, wrote in response to the survey: “The Bank of Japan may communicate to the market that interest rate hikes may usually be at intervals of about three months.” “The focus will be on how strongly it will suggest that the frequency of interest rate hikes may even increase further if conditions permit.”

The data has been highlighting the risk of inflation. The Bank of Japan said on Friday that corporate commodity prices in Japan rose 7.6% year on year in August, little change from the 7.7% increase after the July correction. The latter was the fastest increase since February 2023.

About 46% of respondents believe that the Bank of Japan will speed up the pace of interest rate hikes to about once every quarter. This is in contrast to the opinion that a few months ago it was generally adjusted every six months. About 36% think the interval between rate hikes will be four to five months, while the proportion expected to raise interest rates every six months plummeted from 82% in July to 6% in the latest survey.

US Treasury Secretary Bessent ordered the first coordinated purchase of yen in 28 years in late July to help Japan stop the yen from falling further. This week, he challenged speculators against him with remarks that were extremely unusual for his position, further underscoring his determination to defend the yen.

About 82% of respondents said that it will be difficult for the government led by Prime Minister Takaichi Sanae to oppose the Bank of Japan's interest rate hike this month after the US and Japan coordinate intervention in the yen exchange rate.

The overwhelming majority of respondents said that Bezent's repeated remarks in support of further interest rate hikes were an attempt to ensure that Sanae Takaichi would not hinder the central bank. As we all know, Sanae Takaichi generally supports monetary easing, but there is currently no evidence that she will oppose this month's rate hike.

Naoya Hasegawa, chief bond strategist at Okasan Securities, said, “The United States is not so much about directly urging the Bank of Japan to raise interest rates, it is putting pressure on the government not to hinder the central bank's policy normalization.”

Several interviewees mentioned the importance of next week's policy interest rate vote. The market is particularly concerned about two policy committee members — Sato Ayano and Asada Unichiro. They were all personally selected by Sanae Takaichi to join this nine-member committee.

Ryutaro Kono, Japan's chief economist at BNP Paribas, said: “If they support interest rate hikes, the market is likely to think that the government's pressure on the Bank of Japan to maintain an easing policy will be significantly reduced.” “If they object, investors may see this as a sign that political pressure to keep interest rates low is still present.”

Although economists expect the pace of policy normalization to accelerate, their predictions of interest rates at the end of this austerity cycle have not changed much.

According to the survey, the median forecast remains unchanged at 1.75%, and interest rates will be raised three more times. The highest forecast was also still 2.5%.