Japan Hikes Rates, Reshaping Carry Trade

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2:03Central banks are hiking rates to fight inflation. And on Friday, the Bank of Japan joined the club. What we're seeing here is a milestone for Japan's comeback onto the global stage. Bloomberg's Paul Jackson covers Japan's government and economy out of Tokyo. The BOJ held borrowing costs at or close to zero for three decades. It began increasing rates about two years ago. Today's 25 basis point rate hike continues that trend, but it comes with big risks that harken back to the early 90s. Now, what happened then? The Bank of Japan raised interest rates so quickly that the stock market collapsed.

2:43And it took more than three decades to recover. And it heralded the start of decades of stagnation. It's not just the Japanese economy that's at stake here. Japan is a key player in global markets, and it's the fourth largest economy on the planet. That means that even small movements in interest rates in Japan can have big effects on the rest of the world, including the United States. You know, one thing that you can see with these movements is, you know, once the kind of tide turns, the momentum can move quite quickly. And if it does so, then you'd see quite a bit of strengthening in the yen over the coming months.

3:27This is The Big Take from Bloomberg News. I'm David Gura. Today on the show, what higher interest rates and a more expensive yen could mean for Japanese consumers, global markets, and the lifeblood of the global economy, those all-important U.S. government bonds. My colleague, Won Ha, who hosts The Big Take Asia, talked to Bloomberg's Paul Jackson earlier today, hours after the BOJ hiked rates.

3:56Now, the Bank of Japan just increased its base rate a quarter point to 1.25 percent. Paul, you're there in Tokyo. How are investors and consumers reacting to the move? I mean, if you're an investor in any of the mega banks in Japan, this is good news because how do banks make money? Well, one of them is through borrowing and lending money. So if you've got the interest rate higher, banks usually do well. So the big mega banks, those stock prices will all be going up. So if you're investing in those, it's good. But essentially, it feeds in to the idea that Japan's economy is back and Japan is a place to invest in again.

4:36Now, if you go to consumers, well, let me ask you the question. Are consumers anywhere in the world happy when interest rates go up? Well, usually no. Now, the Bank of Japan Governor Kazuo Oeda says this rate hike is about upside risk. So inflation, in other words. What's the inflation picture in Japan like right now? If you look at the inflation picture now, it's looking a lot more subdued than it did when we were in like 2023, when inflation is over 4%. At the moment, the inflation is actually below the 2 % target of the Bank of Japan. So it might be a little bit subdued now, but economists, the Bank of Japan are all kind of thinking it's going to be above 3 % as we get into early next year.

5:26So, you know, a lot of economists always say you've got to get ahead of the curve on inflation because once you get to high levels of inflation, it becomes difficult to bring them down. Now, the word that probably best describes the Japanese economy for the last 30 years or so is stagnation. The Bank of Japan kept rates around zero for most of that time to try and stimulate the economy. But recently things have changed, right? Base interest rates have risen over the last two years to 1%. So I want to ask you, Paul, what state is the Japanese economy in today? Well, a lot of people like to say Japan is back.

6:06And in many respects, Japan is back. We do have inflation again. We do have yields going up that aren't being manipulated by the country for its economic policy. We have stocks going up and the nation becoming like a destination for investment. So in that respect, Japan is back. However, if you look at the economy in detail, is there evidence that we have a really fast-growing economy now that's materially different to how it was a decade ago? I'm afraid the answer is no. Now, not every country sees the need to hike rates right now. The Bank of England is on pause, for example. So why is Japan doing it and raising rates?

6:56We have fears that the inflation is going to start accelerating again. That's point number one. Point number two, we have this incredibly weak yen. At one point, it was at its weakest in 40 years. That was in July. Do governments want to be intervening, stepping in, buying yen in the market to prop it up. No, that isn't a great solution to the problem of the yen. And I think the other factor here that cannot be taken out of consideration is the United States Treasury Secretary. He's really been going almost over the top with his overt show of American power and influence on global policymaking.

7:41Can Japan totally ignore that pressure? Oh, no. Now, Japan carries a lot of debt. Its gross debt to GDP ratio is anywhere between 180 to 250%, depending on how you measure it. What are the risks associated with increasing rates in Japan right now? The government's debt is twice the size of Japan's economy, which is like the first largest economy in the world. The debt is actually bigger than that. So in terms of debt repayment, that already takes up about a quarter of the annual budget. So if the interest rates go up, then that's making servicing that debt more expensive. Now, Japan's Prime Minister, Sonia Takeichi, has said that she wants to spend to stimulate the economy.

8:31What is Bank of Japan Governor Kazuo Ueda's plan, and how does that mesh with what the Prime Minister wants? ueda's goals are to control inflation in a way that we have a positive growth cycle so he doesn't want to be snuffing out inflation and snuffing out growth no no he wants inflation to stay there it's this idea that an inflation that's stable around two percent is a positive for the economy because people behave differently if you've got inflation if you've got prices going up then you need to spend now you need to buy that television set now or the fridge or freezer whatever uh you know air dryer you need to buy it now because it's going to be more expensive down down the line so it promotes activity i mean if the governor can control inflation to a certain extent that keeps voters off the prime minister's back because it eases the cost of living pressures so it can be good in that respect, but that it increases her borrowing costs.

9:38So if he goes too fast, that makes it very expensive for the government to issue debt. And there's another thing is if the Bank of Japan raises interest rates too quickly, it could snuff out growth in the economy. Now that would cause the prime minister tremendous problems because she is at the moment trying to convince investors across the world that Japan is not a basket case of, like, incredible debt. A quarter point move might not sound dramatic, but Japan is not just another economy raising interest rates to fight inflation. For decades, low rates meant global investors borrowed yen to buy higher yielding investments elsewhere.

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12:50The big focus for central bankers all over the world right now is inflation. That includes Japan, which for 30 years was worried about the opposite dynamic, deflation. Think declining prices every year instead of rising ones. Japan kept its rates close to zero to try and stay out of that spiral, but ended up creating another problem, a weaker yen. Today's decision is aimed at boosting the yen. But as Bloomberg's Paul Jackson tells my colleague Wan Ha, there's a catch. Now, Paul, we can't talk about Japanese interest rates without talking about the yen carry trade, right? For years, investors could borrow incredibly cheap in yen and invest that money somewhere else where it earned a higher return.

13:33How does the raised interest rate affect the carry trade and the price of the yen? The higher the interest rates go in Japan, the less attractive it will be for people who want to conduct a carry trade. It's a market, a global market of interest rates, if you like, and the money flows to where the interest rates are highest. In the simplest terms, if interest rates are much higher in the United States than they are in Japan, why have your money there? So the flow of money goes to the United States away from Japan. So, you know, in terms of supply and demand, what's going to happen? Well, you know, the yen is going to get weaker.

14:15The dollar is going to get stronger. However, if you raise the interest rates in Japan, so you narrow that difference, then the trade-off between do I put my money in the United States or, well, it's starting to get kind of near enough and there's risk of something happening over there and the interest rate, you know, that might change, the exchange rate might change. you know what, I think I'll just keep my money in Japan. It's that kind of thinking that then sways the currency to go in another direction. So raising the interest rates can help prop up the yen in that way. Although today, though, we saw the yen weaken after the BOJ decision came out.

14:52What happened there? If Japan had followed like the Fed the other day with a unanimous vote for rate hike and strong guidance on more to come, the market would have been reassured that we are on that route. We are on that course. But what happened today? We had two dissenters. We had two of the board members saying, hey, look, I'm looking at inflation. It doesn't look that bad to me. I think we should hold. And these two people have been planted on the board by the Prime Minister Takeichi, who we know is a bit reluctant to have interest rate hikes. So people are seeing that descent and thinking, well, there's no way they're going to hike back to back if you've got dissenters.

15:40So that means an October hike is kind of that other question. So then that takes us to December. And does this descent kind of grow on the board or does it stay where it is, it creates doubt. So at that point, you think, right, OK, let's just sell the yen for a bit. Japan's government has spent billions to prop up the yen this year. Now, this will typically make the price of what Japan buys from other countries cheaper for Japanese consumers. But it's not just Japan that wants a more expensive yen. The U.S. does too. Treasury Secretary Scott Besant bought yen in the spot market in late July. Why is the U.S.

16:19so interested in supporting the yen. Point number one is weak currency looks bad to Donald Trump and his administration because it looks like you're getting an unfair trade advantage. The other aspects are that if Japan has to keep intervening in the markets to prop up the yen, it's got to get some money from somewhere. So what does it do? Well, it's got these huge holdings of US treasuries in fact japan has after the u.s is the biggest holder of u.s treasuries in the world so it can sell these uh u.s treasuries to then buy yen if you sell uh the the treasuries and buy yen what's going to happen to treasury yields well they're going to go up a bit right yeah what what does Scott Besson object to its treasury yields going up?

17:16Because that's also creating the likelihood of borrowing costs going up for the United States government that's spending a lot. And is there anything that the US can do to stop that from happening? I think Scott Besson's preferred route for this is for the Bank of Japan to keep raising interest rates on a regular basis so that the yen is propped up by that mechanism rather than through intervention now one other thing to add here is the fact that they've done joint intervention so scott besant has kind of helped japan in a way i mean they hadn't helped japan support the yen since 1998 i mean this is not something that they do at the drop of a hat this is a very transactional u.s administration that have done this for for nothing just for the love of japan i don't think So I think part of the deal is, okay, we'll help you out this time, but you've got to get those interest rates up so that you strengthen the yen that way.

18:17I do think, though, that now the US has some kind of skin in the game, having intervened in the currency. It would now be a bad look if the yen, you know, spiraled out of control and became hugely weak. So I think the idea that the yen is going to go back into the 160s or beyond, I don't think that's going to happen because Scott Besson isn't going to allow it to happen. And Paul, what's ahead now for the Bank of Japan and the Japanese economy? So they have the task of maintaining a positive inflation trend without it getting too much out of control. I think an interest rate hike in December or January is what we would be expecting for their next move.

19:09And then probably another one in the following summer. Now, the Bank of Japan does have an interest in raising interest. And this is the same as central banks all over the world. When the economy is growing and you don't need the interest rates to be low, you want to raise them. Why? Why? Because there could be some crisis in the future. There could be another health crisis. We've got a lot of conflict out there in the world. Could it be some kind of war or something? And if you're a central bank, you want to have some space to lower interest rates so that you can help the economy if there's a big shock.

19:47So the Bank of Japan has an interest in trying to get policy into a normal place so it can deal with shocks in the future. This is The Big Take from Bloomberg News. I'm David Gura. The show is hosted by me, Sarah Holder, and Juan Ha. The show is made by Aaron Edwards, David Fox, Jeff Grokot, Patty Hirsch, Rachel Lewis-Kriskie, Laura Newcomb, Naomi Ng, Julia Press, Tracy Samuelson, Naomi Shaven, Alex Segura, Julia Weaver, Yang Yang, and Taka Yasuzawa. Our executive producer is Nicole Beamsterboer. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer.

20:27Thanks for listening. We'll be back on Monday.

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