Japanese interest rates will continue to rise

If a durable change in the relationship between Japanese and foreign interest rates prompts portfolio reallocations by Japanese investors, brace for a major rebalancing of the global financial system.

The policy rate, at 0.75%, remains negative in inflation-adjusted terms (prices are rising around 3% annually), but less deeply negative than before. 

Meanwhile, the world’s other major central banks—and especially the U.S. Federal Reserve—are cutting their policy rates, narrowing the gap with Japan.

Such movements tend to trigger large and unpredictable shifts in Japanese overseas investment.  

This isn’t a small matter. Japan’s total foreign portfolio investment amounted to around $4.5 trillion at the end of 2024. 

Some portion of this is the so-called carry trade—leveraged, short-term, highly mobile Japanese investments abroad seeking to profit from low domestic rates. 

That’s estimated at anywhere between $160 billion and $500 billion and has been sufficient in the past to cause moments of global volatility when Japanese investors changed their minds en masse.

Joseph C. Sternberg Wall Street Journal Dec. 31, 2025

https://www.wsj.com/opinion/my-murky-crystal-ball-into-2026-1e4aa3b3

The rapid unwinding of leveraged-carry trades is only part of a broader realignment of Japanese and global portfolios as the Bank of Japan returns domestic interest rates to something resembling normal and the yen to valuations that match. 

Don’t expect the process to be quick, or easy.

https://englundmacro.blogspot.com/2024/08/stocks-still-vulnerable-to-further.html

Carry Trade - The Usual Suspect

Market crashes usually have the same mechanism - Unwinding of carry trades is helping

https://englundmacro.blogspot.com/2025/07/a-re-run-of-last-summers-turmoil.html