Japan bids farewell to zero interest rates: Has the "liquidity inflection point" for risky assets arrived?

Original author: Liam, TechFlow

Let me tell you a ghost story:

The yield on Japanese two-year government bonds rose to 1% for the first time since 2008; the yield on five-year government bonds rose 3.5 basis points to 1.345%, a new high since June 2008; and the yield on 30-year government bonds briefly touched 3.395%, a record high.

The significance of this event is not merely that "interest rates have broken through 1%", but rather:

Japan's era of extreme leniency over the past decade or so is being permanently written into history.

From 2010 to 2023, the yield on Japanese two-year government bonds hovered almost between -0.2% and 0.1%. In other words, previously, money in Japan was lent to you for free or even at a loss.

This is because since the bursting of the bubble economy in 1990, the Japanese economy has been trapped in a deflationary trap with stagnant prices, stagnant wages, and weak consumption. In order to stimulate the economy, the Bank of Japan used the world's most aggressive and extreme monetary policies, such as zero interest rates or even negative interest rates, to make money as cheap as possible. Borrowing money was almost free, and you had to pay extra to put your money in the bank, thus forcing people to invest and consume.

The current shift in Japanese government bond yields from negative to positive, rising to 1% , not only concerns Japan itself but also has global implications, affecting at least three aspects:

First, it signifies a complete shift in Japan's monetary policy.

Zero interest rates, negative interest rates, and YCC (yield curve control) are over. Japan is no longer the only major economy in the world to maintain "extremely low interest rates," and the era of loose monetary policy has come to a complete end.

Secondly, it has also changed the global capital price structure.

In the past, Japan was one of the world's largest overseas investors (especially pension funds, insurance companies, and banks). This was due to low domestic interest rates, which prompted Japanese companies to invest heavily overseas in pursuit of higher returns, particularly in the United States, Southeast Asia, and China. Now, with rising domestic interest rates, the incentive for Japanese funds to "go overseas" is decreasing, and they may even be repatriated from overseas to Japan.

Finally, and this is the point that traders are most concerned about, a 1% increase in Japanese interest rates means that the global funding chain that has relied on Japanese carry trade over the past 10 years will experience a systemic contraction.

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

Because carry trade is the hidden engine of global finance.

Yen carry trades are gradually coming to an end.

One important reason why global risk assets such as US stocks and Bitcoin have been able to rise continuously over the past decade or so is the yen carry trade.

Imagine that the money you borrowed in Japan was practically free.

Borrow 100 million yen in Japan with an interest rate of only 0% to 0.1%, then convert that 100 million yen into US dollars, use the money to buy US government bonds with yields of 4% or 5%, or buy stocks, gold, or Bitcoin, and finally convert it back into Japanese yen to repay the loan.

As long as the interest rate differential exists, you can make money; the lower the interest rate, the more arbitrage opportunities you can generate.

There is no publicly available precise figure, but global institutions generally estimate that the scale of yen carry trade is between $1-2 trillion and $3-5 trillion.

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

Many studies even suggest that yen carry trades are one of the real driving forces behind the record highs of US stocks, gold, and Bitcoin over the past decade.

The world has been using "free money from Japan" to inflate risky assets.

The yield on Japan's 2-year government bonds has now risen to 1% for the first time in 16 years, meaning that part of this "free money pipeline" has been shut down.

The result is:

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

Japanese domestic funds are also beginning to flow back to Japan, especially Japanese life insurance companies, banks, and pension funds, which will reduce their allocation to overseas assets.

Global funds are beginning to withdraw from risky assets; a stronger yen often signifies a decline in risk appetite in global markets.

What will be the impact on the stock market?

The US stock market's bull run over the past 10 years has been driven by an influx of cheap global capital, with Japan being one of the biggest pillars.

Rising interest rates in Japan are directly hindering the inflow of large amounts of capital into the US stock market.

Especially given the current extremely high valuations of US stocks and the skepticism surrounding the AI theme, any withdrawal of liquidity could amplify the pullback.

The entire Asia-Pacific stock market was also affected, with markets such as South Korea, Taiwan, and Singapore having previously benefited from yen-carry trade.

As Japanese interest rates rise, funds begin to flow back to Japan, which will increase short-term volatility in Asian stock markets.

As for the Japanese stock market itself, rising domestic interest rates will put pressure on the stock market in the short term, especially for companies that are heavily reliant on exports. However, in the long run, the normalization of interest rates will allow the economy to escape deflation and re-enter a development phase, and the reconstruction of the valuation system will actually be beneficial.

This may also be why Buffett continues to increase his investment in the Japanese stock market.

On August 30, 2020, his 90th birthday, Buffett first publicly disclosed that he held approximately 5% of the shares in each of Japan's five largest trading companies, with a total investment value of approximately $6.3 billion at the time.

Five years later, with rising stock prices and continued investment, the total market value of Buffett's holdings in Japan's five largest trading companies has exceeded $31 billion.

In 2022–2023, the yen fell to a near 30-year low, and Japanese equity assets as a whole suffered a major blow. For value investors, this was a typical investment opportunity with cheap assets, stable profits, high dividends, and the possibility of a currency reversal. Such an investment opportunity was too attractive.

Bitcoin and Gold

Aside from the stock market, what impact does the appreciation of the Japanese yen have on gold and Bitcoin?

The pricing logic for gold has always been simple:

A weaker dollar leads to higher gold prices; lower real interest rates lead to higher gold prices; increased global risks lead to higher gold prices.

Each of these points is directly or indirectly related to the turning point in Japan's interest rate policy.

First, rising interest rates in Japan mean an appreciation of the yen, which accounts for a significant 13.6% of the US dollar index (DXY). A stronger yen puts direct pressure on the DXY, and when the dollar weakens, gold naturally loses its biggest suppressive force, making it easier for prices to rise.

Secondly, the reversal in Japanese interest rates marks the end of the "cheap money" phenomenon that has plagued the world for over a decade. Yen carry trades have begun to flow back, Japanese institutions are reducing overseas investments, and global liquidity is consequently declining. During a liquidity contraction cycle, funds tend to withdraw from highly volatile assets and shift towards gold—a "settlement asset, safe-haven asset, and risk asset with no counterparty."

Third, if Japanese investors reduce their purchases of gold ETFs due to rising domestic interest rates, the impact will be limited, as the main drivers of global gold demand are not Japan, but rather central bank gold purchases, ETF holdings, and the long-term upward trend in purchasing power in emerging markets.

Therefore, the impact of this surge in Japanese yields on gold prices is clear:

There may be short-term fluctuations, but the medium- to long-term outlook remains bullish.

Gold is now in a favorable combination of "interest rate sensitivity + weakening dollar + rising safe-haven demand", and the long-term outlook is positive.

Unlike gold, Bitcoin is one of the most liquid risk assets globally, trading around the clock and highly correlated with the Nasdaq. Therefore, when Japanese interest rates rise, yen carry trades return, and global liquidity contracts, Bitcoin is often one of the first assets to fall. It is exceptionally sensitive to the market, acting like a "liquidity electrocardiogram" for the market.

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

Japan's entry into an interest rate hike cycle signifies rising global debt costs, increased volatility in US Treasury bonds, and heightened fiscal pressures on various countries. Against this macroeconomic backdrop, assets "without sovereign credit risk" are being reassessed: in traditional markets, it's gold; in the digital world, it's Bitcoin.

Therefore, Bitcoin's path is also clear: in the short term, it falls with risky assets, but in the medium term, it receives new macro-level support due to rising global credit risk.

In short, the era of risky assets that have thrived on "free Japanese funds" over the past decade or so is over.

The global market is entering a new interest rate cycle, a more real and brutal one.

From stocks and gold to Bitcoin, no asset is immune to the effects of the pandemic.

When liquidity recedes, assets that can hold their ground become more valuable. During cyclical transitions, the most crucial skill is understanding the hidden funding chains.

The curtain has been raised on a new world.

Next, we'll see who adapts faster.