Japan's Central Bank to Sell $534 Billion in Local Stocks and Raise Interest Rates to Highest Level Since 1995

All this while 10-Year Bond Yields Hit Highest Level Since 2007 and Inflation Remains Above Target

You don't need to become a Japan expert.

But understanding what's happening in Tokyo helps explain the volatility we've seen in assets worldwide – including Bitcoin – and prepares you for what's to come.

Let's go:

For approximately three decades, Japan has been the world's laboratory for ultra-loose monetary policy.

While the Fed and the ECB raised and lowered rates in normal cycles, Japan was stuck at zero – or sometimes even negative – trying to combat the deflation that has plagued the economy since the 1990s.

This week (December 18-19), the Bank of Japan is expected to raise rates to 0.75%.

That seems small, but it's the highest level of Japanese interest rates since 1995.

More importantly, it signals that Japan is trying to join the rest of the world in having "normal" monetary policy.

THE YEN CARRY TRADE

This is where it gets relevant.

Imagine you could borrow money at almost 0% interest.

What would you do?

You would probably take the loan and invest in something that pays more – US Treasuries, tech stocks, bitcoin, emerging market bonds, anything.

That's exactly what hedge funds, institutions, and traders have been doing for years.

They borrow cheap yen in Japan, convert it to dollars, and buy higher-yielding assets elsewhere.

This is the "yen carry trade."

The problem? This operation only works when:

• Japanese interest rates remain low
• The yen remains weak or stable
• Your investments don't fail

When any of these conditions change, traders need to unwind their positions.

This means selling their investments (stocks, bonds, crypto) and buying yen to repay their loans.

When this happens on a large scale, it creates a cascade of selling in global markets.

THIS WEEK'S INTEREST RATE RISE COULD BE DIFFERENT

The good news: speculators already have net long exposure to the yen, making a sharp reaction to the BOJ increase unlikely.

In other words, the market has been expecting this, and many traders have already adjusted.

Furthermore, Japanese bond yields have risen throughout this year, so the next interest rate hike reflects official rates reaching the market, rather than surprising it.

But the risk hasn't disappeared – it's just been postponed. The real question is: what comes next?

THE BIGGER CONTEXT: JAPAN IS UNRAVELING EVERYTHING

The interest rate hike is just one piece. The BOJ is also:

1. Selling its equity holdings

Here’s something most Western investors don’t realize: the Bank of Japan owns about 7% of the entire Japanese stock market through ETFs. That portfolio is valued at ¥83.2 trillion ($534 billion).

They started this in 2010 to combat deflation – literally buying stocks to support prices and confidence. No other major central bank has done this.

Now they are unraveling. They are being careful because a rapid process would risk triggering a widespread sell-off, but still, it removes a guaranteed buyer from the market.

2. Reducing bond purchases

Just like the Fed’s quantitative tightening, the BOJ is also buying fewer Japanese government bonds, letting its balance sheet shrink.

THE POLITICAL QUESTION

Japan's new Prime Minister, Sanae Takaichi, last year described the idea of ​​an interest rate hike as "stupid."

She is an advocate of "Abenomics"—the easy money and heavy stimulus approach of the late Shinzo Abe.

But here's the twist: she now faces a tightening cost of living that has eroded support for her ruling party.

Japanese inflation has been above the BOJ's 2% target for more than 40 consecutive months. Voters are angry about rising prices.

So Takaichi finds herself in a dilemma.

She wants low rates to stimulate growth, but needs the BOJ to tighten policy to strengthen the yen and reduce import-driven inflation.

Japan's first female prime minister has avoided criticizing Ueda's plans to reduce monetary easing since taking office in October, prioritizing the fight against inflation.

Meanwhile, Japan already has the highest debt-to-GDP ratio among major economies – around 240%.

And Takaichi wants to run large fiscal deficits on top of that. More than 60% of planned spending will come from government borrowing.

Higher interest rates + massive debt = increasing interest costs for the government.

This is a mathematical problem that gets harder every year.

KEY DATA TO WATCH

1. Global Liquidity

Japan has been a source of cheap money for the world. When that tap is turned on, liquidity in all markets – including US stocks and crypto – can be affected. The yen carry trade is not some obscure technicality; it has been a significant source of funding for risk assets globally.

2. Currency Movements

If the yen strengthens significantly (say, from 155 to 140 against the dollar), it can trigger forced selling across all asset classes as carry trades are unwound. A stronger yen has typically coincided with downward pressure on bitcoin, while a weaker yen has tended to support higher prices.

3. Bond Market Canary

The Japanese government bond market is showing stress. Yields on 10-year Japanese government bonds have risen to their highest levels since 2007. If Japan, with its massive debt, begins to have trouble financing itself affordably, this could reverberate through global bond markets.

4. Precedent for Other Central Banks

The BOJ is the first major central bank globally not only to buy equity ETFs but also to begin selling them, setting a precedent for other central banks. How this unfolds will inform how other central banks approach the unwinding of unconventional policies.

CONCLUSION

Japan is attempting something unprecedented: normalizing monetary policy after 30 years of emergency measures, while simultaneously grappling with massive government debt, a weak currency, persistent inflation, and a political leader who ideologically prefers easy money.

For Western investors, the key points are:

Short term: This week's interest rate hike is largely priced in and shouldn't cause major disruption on its own.

Medium term: Watch the yen. If it strengthens sharply against the dollar, new carry trade unwinds could put pressure on risk assets once again.

Long term: Japan's fiscal situation (high debt + rising interest rates + fiscal expansion) is a slow-moving structural risk that could eventually become very important.