Everyone Is Watching the US. Japan Makes the Key Decision Today

Japan is announcing its interest-rate decision today. Markets are almost certain that rates will be raised.

The common view is that another hike could bring the rally to an end.

I see it differently. In my view, the hike removes uncertainty rather than ending the rally.

The fuel for the next phase is also clear: the interest-rate gap between the two countries.

Read this carefully.

US interest rates are currently between 3.75% and 4%.

Japan’s rate stands at 1%. Today, it is expected to rise to 1.25%.

Even after such a hike, the gap would still be more than 2.5 percentage points.

What does that gap actually do?

Think of it this way.

Water keeps flowing as long as there is a difference in elevation. You cannot stop the flow while that difference remains.

Interest-rate differentials work in much the same way.

A fund that borrows in Japan at 1.25% and moves into the dollar while taking on currency risk can earn close to 4%. As long as the yen does not strengthen significantly, that gap becomes the source of the return.

That has been one of the forces behind the rally of recent years.

As long as the differential remains, the flow of capital can continue. Today’s hike does not eliminate the gap. It only narrows it somewhat.

Can Japan actually close the gap?

The futures market is pricing in a Japanese rate of 1.5% by the end of the year and 2% within two years.

Japan cannot move much faster because its debt is more than twice the size of its national income, above 230%.

The 10-year Japanese government bond yield crossed 3% this month for the first time since 1996, while roughly half of the bonds are held by its own central bank. That means the central bank itself absorbs the losses as rates rise.

The rule is simple.

A heavily indebted government cannot afford to pay interest rates high enough to keep pace with inflation. If it does, servicing its own debt becomes increasingly difficult.

Japan is trying to catch up with the US, but it cannot keep pace.

Now, let’s get to why I am not expecting a decline this time.

Japan has raised interest rates five times since 2024.

The first hikes triggered sharp market reactions. In August 2024, the Japanese stock market fell 12% in a single day, and the selling spread across global markets.

The market has learned how this mechanism works.

The selling happens in the weeks leading up to the decision. By the time the decision arrives, much of the adjustment has already taken place.

This time appears to be no different.

The yen has moved from 164 to 156 since late July, gaining 2.3% in just the past month. Expectations for a rate hike have already been priced in to a significant extent.

I wrote this back in July:

A bull market does not begin simply because the yen strengthens. It begins when the sharp move in the yen comes to an end.

Today could be that day.

If the yen jumps sharply after the decision, risk assets could come under pressure once again. But because the interest-rate differential would still remain, that move would not necessarily be lasting.

The bigger picture is this.

What has fueled the rally is a cheap yen.

What creates a cheap yen is the interest-rate gap between the two countries.

What lies behind that gap is Japan’s debt.

As long as the debt remains, this chain does not fundamentally break.

Japan may raise rates today. What it cannot change is the gap between itself and the United States.

In my view, as long as that gap remains open, money will continue to flow into risk assets.

This is my personal analysis.

I am following developments closely and will keep you informed.

Kaynak: Penguin X @ThePenguinBTC