Japan Ends Zero Interest Rate Policy: Risk Assets Face Their Worst Fear, the "Liquidity Turning Point"

Original Article Title: "Japanese Government Bond Yield Breaks 1%, Beginning of a 'Ghost Story' in the Global Financial Market"

Original Article Author: Liam, Deep Tide TechFlow

Let me tell you a ghost story:

The two-year Japanese government bond yield has risen above 1% for the first time since 2008; the five-year government bond yield has increased by 3.5 basis points to 1.345%, hitting a new high since June 2008; the 30-year government bond yield briefly touched 3.395%, reaching a historical high.

The significance of this event is not just the "yield breaking 1%," but:

Japan's extreme era of easing over the past decade is being permanently inscribed into history.

From 2010 to 2023, the two-year Japanese government bond yield has been fluctuating between -0.2% and 0.1%. In other words, Japan's money was essentially free, or even paid you to borrow.

This was due to Japan's economy being stuck in a deflation trap with stagnant prices, wages, and weak consumption since the burst of the bubble in 1990. To stimulate the economy, the Bank of Japan implemented the world's most aggressive and extreme monetary policy, including zero interest rates and even negative interest rate policies, making funding as cheap as possible. Borrowing money was almost free, and depositing money in the bank would cost you. This was done to compel everyone to invest and consume.

Now, Japan's government bond yields have shifted from negative to positive, rising to 1%, which not only affects Japan itself but also has global implications in at least three aspects:

Firstly, it signifies a complete reversal of Japan's monetary policy.

The era of zero interest rates, negative interest rates, and YCC (Yield Curve Control) has ended, and Japan is no longer the only major economy maintaining "ultra-low interest rates," bringing the era of easing to a complete end.

Secondly, it has also altered the global fund pricing structure.

Previously, Japan was one of the world's largest overseas investors (especially pension funds like GPIF, insurance companies, and banks) due to its low domestic interest rates. To seek higher yields, Japanese companies heavily invested overseas in the U.S., Southeast Asia, and China. Now, as domestic interest rates rise, the "outward investment drive" of Japan's funds will decrease, and they may even flow back from overseas to Japan.

Lastly, and the point most watched by traders, a 1% increase in Japanese interest rates means that the global funding chain that relied on Japanese carry trade for the past decade will experience a systemic contraction.

This will affect the US stock market, Asian stock markets, foreign exchange market, gold, Bitcoin, and even global liquidity.

Because carry trade is the hidden engine of the global financial system.

Yen Carry Trade Gradually Coming to an End

Over the past decade, global risk assets such as the US stock market and Bitcoin have been able to continuously rise, and a key reason for this is the Yen Carry Trade.

Imagine borrowing money in Japan at almost no cost.

Borrowing 100 million yen in Japan with an interest rate of only 0%~0.1%, then converting this 100 million yen into US dollars to buy US treasury bonds with yields of 4%~5%, or to buy stocks, gold, Bitcoin, and finally converting back to Japanese yen to repay the loan.

As long as there is an interest rate differential, you make money, and the lower the interest rate, the more arbitrage opportunities.

There is no exact public number, but global institutions generally estimate that the scale of the Yen Carry Trade ranges from 1 to 2 trillion US dollars on the low end and from 3 to 5 trillion US dollars on the high end.

This is one of the largest and most invisible sources of liquidity in the global financial system.

Many studies even argue that Yen Carry Trade is one of the true drivers behind the record highs of the US stock market, gold, and BTC over the past decade.

The world has been using "Japan's free money" to boost risk assets.

Now, Japan's 2-year government bond yield has risen to 1% for the first time in 16 years, signaling that part of this "free money pipeline" has been shut off.

The result is:

Foreign investors can no longer borrow cheap yen for arbitrage, putting pressure on the stock market.

Domestic funds in Japan are also starting to flow back into the country, especially from Japanese life insurers, banks, and pension funds, reducing their allocation to overseas assets.

Global funds are beginning to withdraw from risk assets, and a stronger yen often means a decreased global market risk appetite.

How Will This Impact the Stock Market?

The US stock market has experienced a bull market for the past 10 years, driven by the influx of global cheap funds, with Japan being a major supporter.

Rising Japanese interest rates directly hinder a large amount of capital flowing into the US stock market.

Especially with the current high valuation of the US stock market and doubts about AI themes, any liquidity withdrawal could exacerbate a pullback.

The entire Asia-Pacific stock market has also been affected, with markets in South Korea, Taiwan, Singapore, and other countries benefiting from the yen carry trade in the past.

As Japanese interest rates rise, funds start flowing back to Japan, leading to increased short-term volatility in Asian stock markets.

As for the Japanese stock market itself, with domestic interest rates rising, the stock market will also face short-term downward pressure, especially for companies heavily reliant on exports. However, in the long term, rate normalization will help the economy escape deflation, re-enter a growth stage, rebuild valuation systems, and be seen as positive.

Perhaps this is also the reason why Warren Buffett continues to increase his investment in the Japanese stock market.

On August 30, 2020, Buffett, on his 90th birthday, first publicly disclosed that he held about 5% stakes in the top five Japanese trading companies, with a total investment value of around $6.3 billion at that time.

Five years later, with stock prices rising and continuous addition to his holdings, the total market value of Buffett's holdings in the top five Japanese trading companies has surpassed $31 billion.

In 2022-2023, the yen fell to a nearly 30-year low, and Japanese equity assets overall experienced a "bone-breaking" moment. For value investors, this represents a classic opportunity of assets being undervalued, stable profits, high dividends, and the potential for a currency reversal... An irresistible investment opportunity.

Bitcoin and Gold

Aside from the stock market, how does the yen's appreciation affect gold and Bitcoin?

The pricing logic of gold has always been simple:

A weak dollar leads to a rise in gold prices; a decrease in real interest rates leads to a rise in gold prices; global risks increase, leading to a rise in gold prices.

Each of these factors has a direct or indirect connection to Japan's interest rate policy turning point.

Firstly, an increase in Japanese interest rates means yen appreciation, and within the U.S. Dollar Index (DXY), the yen accounts for as much as 13.6%. A stronger yen puts direct pressure on the DXY. When the dollar weakens, gold naturally loses its strongest suppressive force, making it easier for the price to rise.

Secondly, the reversal of Japanese interest rates signifies the end of over a decade of "global cheap money." Yen carry trades start flowing back, Japanese institutions reduce overseas investments, and global liquidity subsequently decreases. During a period of liquidity contraction, funds tend to withdraw from high-volatility assets and turn to gold, a "settlement asset, safe-haven asset, no counterparty risk asset."

Thirdly, if Japanese investors reduce their purchases of gold ETFs due to the local interest rate hike, this impact is limited since the main driver of global gold demand is not in Japan but in the long-term trends of central bank gold purchases, ETF increases, and purchasing power in emerging markets.

Therefore, the impact of this round of Japanese yield surge on gold is clear:

Short-term may see volatility, but the medium to long-term outlook remains bullish.

Gold is once again in a favorable combination of "rate sensitivity + weakening US dollar + risk aversion rising," with a long-term positive outlook.

Unlike gold, Bitcoin is considered the most liquid global risk asset, trading around the clock and highly correlated with the Nasdaq. Therefore, when Japanese rates rise, yen carry trade unwinds, and global liquidity tightens, Bitcoin is often one of the first assets to decline, as it is extremely sensitive to market anomalies, acting like a "market liquidity ECG."

However, short-term weakness does not equate to long-term pessimism.

Japan entering a rate hike cycle signifies an increase in global debt costs, heightened US bond volatility, and rising fiscal pressures worldwide. In this macroeconomic context, assets with "sovereign credit risk" are being reevaluated: in the traditional market, it is gold, while in the digital world, it is Bitcoin.

Therefore, Bitcoin's path is also clear: short-term volatility alongside risk assets downturn, but in the medium term, it welcomes new macro-level support due to rising global credit risk.

In conclusion, the era of risk assets thriving on "free money from Japan" over the past decade has come to an end.

The global market is entering a new rate cycle, a more genuine and also more brutal cycle.

From the stock market, gold to Bitcoin, no asset can stand alone.

When liquidity recedes, assets that can hold firm are more valuable. As the cycle transitions, understanding that hidden money chain is the most critical ability.

The curtain of the new world has already been drawn.

Next, it's about who adapts faster.