US and Japan Interest Rate Hikes Loom: Which Assets Are Most at Risk?

In global markets this week, the main themes are Japan's interest rate hike and the Federal Reserve meeting. For risk assets, this week is destined to be anything but calm.

Three months ago, Wall Street was still discussing when rates would be cut. Wash had just taken office, and the market was willing to give the new chair some leeway. Inflation was trending down, employment was easing, so a rate cut was just a matter of time. But the financial world is fickle, and the script everyone had imagined simply didn't play out.

May CPI rose 4.2% year-over-year, 0.5% month-over-month. Energy prices increased 3.9% month-over-month. Core CPI remained around 2.9% year-over-year. Employment also didn't give the Fed an immediate reason to turn dovish. Non-farm payrolls added 172,000 in May, and the unemployment rate held steady at 4.3%. This means the Fed is now facing an awkward combination: inflation is re-emerging, employment hasn't collapsed significantly, AI-related investments are still supporting economic resilience, the reasons for a rate cut are weakening, while conditions for a hike are slowly building.

Meanwhile, the Bank of Japan holds its policy meeting on June 15-16, and the market has almost priced in a 25 basis point hike as the base case. Polymarket's "Bank of Japan Decision in June" market shows the probability of a 25bp hike at about 98.3%, no change at about 1.45%, and a 50bp+ hike at about 0.55%.

Many should still remember that Japan's previous rate hikes significantly impacted overall financial markets. This time around, facing Japan's rate hike on Tuesday and the Fed's FOMC meeting on Thursday, will the market decline?

Wash's "Debut" and Rising Odds of a Fed Rate Hike

Let's first look at the Fed.

The possibility of a rate cut seems largely off the table. On Polymarket, "No Rate Cut in 2026" sits at about 70.35%, "Rate Cut Before July" at about 2.35%, and "Rate Cut Before December" at only about 23%. 70% are betting there won't be any cuts this year. For the year-end rate range, maintaining a ceiling of 3.75% is around 37%, 4.00% is about 32.5%, 4.25% is about 11.25%, and 4.50% or higher is about 3.35%. Combined, the probability of 4.00% or higher is about 47%.

Market consensus on Wash is that during his debut, i.e., this week's FOMC meeting, he likely won't raise rates. The risk of a rate hike is mainly concentrated in the third quarter and beyond. Several markets on Polymarket illustrate this consensus well:

"Fed rate hike in 2026?" shows the probability of a hike anytime in 2026 at about 34.5%; "Fed rate hike by...?" shows around 0.65% before June, 6.15% before July, 24.5% before September, and 32% before October; In "Fed Decision in July," a 25bp hike in July is about 3.15%, a 50bp+ hike is about 0.3%, and no change is about 93.5%; In "What will the Fed rate be at the end of 2026?", the probability of the year-end rate ceiling being 3.75% is about 37%, 4.00% is about 32.5%, 4.25% is about 11.25%, and 4.50% or higher is about 3.35%.

Looking at more specific probabilities and data. The probability of a rate hike before July 29 is about 10.3%, before October 28 is about 47.1%, and before December 9 is about 66.3%. Polymarket is more conservative, giving 34.5% for "Fed rate hike in 2026?", about 24.5% before September, and about 32% before October. For this month, CME FedWatch gives a 98.5% chance of no change, while Polymarket gives 99.55%.

The US is likely to hold steady this week, but "holding steady" and "not tightening" are two different things.

If Wash acknowledges during the press conference that inflation risks are once again outweighing growth concerns, if the dot plot shifts the 2026 median rate from a dovish direction to unchanged or even upward, or if the "dovish lean" language is removed from the statement, the market will effectively tighten policy for the Fed itself.

The first to react would be short-term US Treasuries. The 2-year and 1-year yields move directly with the Fed's path. Once the market shifts from a "rate cut later" narrative to a "possible rate hike later" one, short-term yields rise. The dollar would also strengthen, and a strong dollar itself represents a form of global tightening.

Within US stocks, high-valuation growth stocks and long-duration AI assets are most sensitive. Higher rates reduce the present value of future cash flows, make financing more expensive, and make markets less willing to pay a premium for stories that haven't materialized yet. Small caps, micro caps, and unprofitable tech stocks have more fragile logic. These companies rely on cheap money, and when money isn't cheap anymore, their valuations are the first to collapse.

In a true tail-risk scenario, if the Fed hikes rates despite the 98.5% probability of "no change," the shock would be severe. Short-term rates would jump, the dollar would surge, and leveraged positions would be forced to de-risk. This isn't saying it will happen, but the probability implies that if it does, no one will have time to react.

The importance of Wash's "debut" is amplified by the market partly because he might change the Fed's communication style. People like Timiraos, who have tracked the Fed for a long time, have clearly stated the issue: For Wash, symbolic adjustments like the dot plot, statement language, and press conference rhythm can be done quickly. But truly changing the Fed's communication system requires long-term persuasion and internal collaboration. This week's meeting might be the first step.

Across the Pacific: The "Curse" of Japan's Rate Hikes

Now look at Japan. The Bank of Japan meets on June 15-16, and Polymarket gives a 98.3% probability for a 25 basis point hike. If implemented, the policy rate would rise from 0.75% to 1.00%, the highest since 1995.

The logic forcing Japan's hand is straightforward. Middle East conflicts push up oil prices; Japan is a typical energy importer, and a weak yen magnifies import costs. Wages are rising, service prices are rising, and inflation expectations are starting to loosen. If rates remain low, the market would question whether the BOJ cares about inflation at all.

The hike itself is uncontroversial. However, a key concern is this: Over the past few years, massive amounts of global capital borrowed in low-yielding yen, converted it to dollars or other high-yield assets, bought US Treasuries, stocks, credits, and some indirectly flowed into high-volatility risk assets. This structure is built on a premise: Japanese rates are low enough, yen financing is cheap enough, and the central bank is slow enough. This means that if the market believes Japan's rate normalization is continuous, carry trades become fragile, yen shorts get squeezed, and global leveraged capital begins to contract.

The market's fear of a Japanese rate hike is not unfounded. Over the past two decades, almost every time the Bank of Japan tried to lift rates from near zero, something went wrong in global markets.

The first time was August 2000. The BOJ raised rates from 0% to 0.25%, coinciding with the peak of the US internet bubble. Within three months of the hike, the Nasdaq fell 35%. Japan's own economy couldn't withstand it, quickly sliding back into recession, forcing the BOJ to cut rates back to zero in 2001.

The second time was from 2006 to 2007. The BOJ raised rates to 0.5% in two steps, first in July 2006 and again in February 2007. The timeline almost perfectly matches the incubation period of the US subprime mortgage crisis. Subprime mortgages began blowing up in the summer of 2007, Lehman Brothers collapsed in 2008, and the global financial crisis erupted. The BOJ was once again forced to cut rates back to zero.

The third time was July 31, 2024. The BOJ raised rates from 0% to 0.25%, a small move, but the market reaction was extreme. On August 5, the Nikkei 225 crashed 12.4% in a single day, its largest drop since Black Monday in 1987. South Korea's KOSPI triggered a circuit breaker, while the Nasdaq and S&P 500 fell 3.4% and 3% respectively. The VIX panic index surged above 65. The transmission mechanism of that crash was clear: The BOJ hike triggered a sharp yen rally, forcing the unwinding of carry trades that borrowed yen to buy overseas assets. Selling stocks to repay yen led to a collective rout. To meet margin calls, fund managers even sold "safe-haven assets" like gold and BTC. During a liquidity crisis, correlations across all assets approach 1. The editor still vividly remembers the devastation in the markets that day.

Therefore, the more important question is what signal the Japanese government gives at tomorrow's press conference: How high will rates go?

US Stocks, US Bonds, Bitcoin: Who is Most at Risk This Week?

As mentioned earlier, during the Bank of Japan's three past hiking cycles, global markets mostly declined.

However, a BOJ rate hike itself doesn't necessarily trigger a sell-off. Sell-offs usually occur when other fragile leverage points exist. For example, 2000 and 2007 coincided with larger bubbles in other countries. August 2024 involved a surprise that caught heavily positioned markets off guard. Subsequent, well-anticipated hikes didn't cause significant issues.

This time, the 25bp hike is already priced in at 98.3%, leaving almost no room for surprise. Based on experiences from December 2024 and January 2025, the hike itself is likely to be absorbed smoothly. However, there are two additional variables this time.

First, Governor Kazuo Ueda is hospitalized with an infectious liver cyst and is expected to miss this meeting and the subsequent press conference. According to public reports, Deputy Governor Ryozo Himino will serve as acting chair for the meeting, while Deputy Governor Shinichi Uchida will host the post-meeting press conference. This arrangement is unlikely to change the direction of the hike. However, the market is less familiar with Uchida's communication style compared to Ueda's, which could amplify volatility in the interpretation of remarks. A statement like "future decisions will be data-dependent" versus "there is still room for normalization" may seem similar but conveys entirely different signals to traders.

Second, the US is meeting in the same week. There's only one day between the BOJ decision and the FOMC meeting. If the BOJ hike is met with a mild market reaction, but Wash sounds hawkish the next day, the pressure layers stack. Conversely, if the market is already nervous after the BOJ hike, Wash adding fuel to the fire could lead to an excessive short-term emotional reaction. Having two central banks deliver results back-to-back amplifies volatility by its very nature.

Let's analyze the assets one by one:

US Treasuries are likely to be the first to react this week. Short-term yields move directly with the Fed's path, with the 2-year and 1-year being most sensitive. If Wash's press conference is hawkish and the dot plot is revised upward, short-term yields will rise, reflecting a market repricing of "later cuts" or even "a hike this year." Long-term yields are more complex; the 10-year might not surge in tandem. If the market starts worrying that high rates will damage the economy, the yield curve could flatten further or even deepen its inversion. On the Japanese side, if Uchida signals further hikes, Japanese Government Bond (JGB) yields would also rise. If Japan's massive $1.13 trillion US Treasury holdings show any marginal loosening, it could feedback negatively on US Treasury supply-demand dynamics.

The US Dollar (USD) is likely to find support. A hawkish Fed tilt boosts expected returns on USD-denominated assets, strengthening the DXY. Theoretically, a BOJ hike is yen-positive and dollar-negative, but the actual outcome depends on the tone: If the BOJ follows the hike with dovish signals, the yen might weaken rather than strengthen, making the dollar index stronger. With two central banks meeting the same week, the relative movement of the USD and JPY will be very sensitive, and FX market volatility is likely to increase. Asian currencies and emerging market currencies will come under pressure; a strong dollar itself is a form of global tightening, draining dollar liquidity overseas.

Within US stocks, divergence will be significant. High-valuation growth stocks, long-duration AI assets, small caps, micro caps, and unprofitable tech names are most vulnerable. Higher rates reduce the present value of future cash flows, make financing pricier, and make markets unwilling to pay for unfulfilled stories. The Russell 2000 and companies reliant on cheap money are the first to be affected. Bank stocks have a more complex reaction – short-term spreads might benefit, but if the curve remains inverted and credit risk rises, it's not necessarily positive. Defensive stocks are relatively resilient, but "bond-proxy assets" like utilities and REITs will also see their valuations pressured by higher rates. The S&P 500 closed near 7382 last Friday, and the Nikkei 225 was at 66078. If both central banks lean hawkish this week, US and Japanese stocks, particularly indices with heavy tech weightings, will come under pressure.

Japanese stocks are in a unique position. A BOJ rate hike itself is bad news for export-oriented Japanese companies because a stronger yen erodes overseas profits. However, if the size and pace of the hike are within expectations, Japanese stocks may not fall sharply, as shown by the experience in December 2024 and January 2025. The real risk remains in post-meeting communication. If Uchida signals further normalization, the Nikkei might fall first before stabilizing.

Gold will be pulled in two directions. Rising real rates and a stronger USD are typically bearish for gold. However, if the rate hike is driven by energy shocks, geopolitical risks, and runaway inflation, safe-haven demand will support the price. Gold is likely to trade in a high range this week, with the direction depending on what the market fears more: rising rates or uncontrollable inflation. Crude oil depends more on supply, demand, and geopolitics. Conflict with Iran is still simmering. If the rate hike stems from oil pushing up inflation, oil prices may not immediately fall. However, if the market starts pricing in a demand slowdown, industrial metals and crude oil will face pressure later.

Credit bonds and real estate are slow-moving variables, but the direction is clear. High-yield bond spreads will widen, financing costs rise, and assets sensitive to commercial real estate, REITs, and mortgages will face pressure. Emerging markets with high dollar-denominated debt will also struggle more, as capital outflows intensify.

The crypto market is also under pressure in this macro environment. BTC is currently around $65,000, having fallen from $72,000 in early June following the CPI release, reaching around $61,500 before recovering slightly in recent days. This position is inherently unstable. When it broke below $62,000 on June 5, on-chain long liquidations exceeded $1.5 billion, and Bitcoin spot ETFs saw net outflows of $2.7 billion for the week. Although the price has recovered some, the position structure is not healthy. Bitcoin partially possesses macro asset attributes; it won't necessarily collapse when rates rise, but it is also difficult for it to rally independently. ETH, SOL, altcoins, memes, and small-cap coins are more fragile. These assets thrive on liquidity overflow and risk appetite. Once the market starts comparing the yield attractiveness of cash, short-term bonds, and money market funds, high-beta assets are the first to be cut. Contract market funding rates have fallen, on-chain risk appetite is cooling – an episode already seen in early June.