Japan's senior government officials gave the green light for a rate hike in December. Will the butterfly effect trigger a global market storm to replay?

According to informed sources, if the Bank of Japan decides to raise interest rates in December, the main officials of the Koike administration will not try to stop it, despite some senior officials opposing the timing of the rate hike. As market expectations for a 25 basis point rate hike by the Bank of Japan at its policy meeting on December 19 increase, the position of the Japanese government increases the likelihood of a rate hike this month. At the time of drafting, the dollar fell against the yen to 154.81 yen per dollar. The yield on the two-year Japanese government bonds rose to 1.022%. Bank of Japan's December rate hike "arrow on the string" It has been reported by three Japanese government sources that the Bank of Japan is likely to raise interest rates this month, and the Japanese government will tolerate this move. Although the Bank of Japan is independent of the government, according to a joint agreement in 2013, both sides agreed to enhance policy coordination to overcome deflation and achieve sustainable economic growth. After Koike Yuriko was elected as the Prime Minister of Japan, her support for loose monetary policy has sparked speculation in the market that she might try to influence the Bank of Japan to raise rates at a slower pace. However, analysts have pointed out that the political pressure on the Bank of Japan to maintain low interest rates seems to have weakened. Former Bank of Japan monetary policy chief Muto Toshiro expects that since one of Koike Yuriko's key priorities is to help Japanese households cope with high inflation, this prime minister, known for advocating loose monetary policy, will allow the Bank of Japan to move forward with the rate hike. It is worth mentioning that earlier this week, Bank of Japan Governor Ueda Kikuo sent a clear hawkish signal. Ueda Kikuo stated on Monday in a speech to local business leaders in Nagoya that the Bank of Japan "will weigh the pros and cons of raising policy interest rates, and make decisions in a timely manner based on domestic and international economic, inflation, and financial market conditions." He added that any rate hike is simply an adjustment to the degree of looseness, and the overall environment remains loose. These remarks suggest that the Bank of Japan is highly likely to take action this month. By mentioning a specific policy meeting, Ueda Kikuo was likely hinting that the possibility of interest rate action is increasing at the time. Looking back to the end of December last year, the Bank of Japan governor explicitly promised to carefully assess the economic situation at the next meetingand it was at that meeting that the Bank of Japan ultimately decided to raise rates. Even before Ueda Kikuo made his speech on Monday, several Bank of Japan officials had hinted that the Bank of Japan might be about to raise rates. The newest member of the Bank of Japan Policy Board, Masuda Kazuyuki, stated that the timing of the rate hike is approaching. Another board member, Koeda Junko, also stated that the Bank of Japan should promote policy normalization, although she did not indicate whether the next step should be taken in December. Even the dovish member Nakao Asahi pointed out last week that the risk of adjusting policies too late is increasing. Some recent economic data also support market expectations for a rate hike by the Bank of Japan. According to data released by the Japanese Ministry of Internal Affairs and Communications last Friday, consumer prices in Tokyo excluding fresh food rose by 2.8% year-on-year in November, slightly higher than the median economist estimate of 2.7%, and in line with the previous month's result; core CPI, which excludes energy, also rose by 2.8%, unchanged from the previous month. Meanwhile, the Ministry of Economy, Trade and Industry reported that industrial production rose by 1.4% month-on-month in October, far exceeding the market's forecast of a 0.6% decline. These economic data may boost the Bank of Japan's confidence in the gradual realization of its economic outlook and further drive the central bank to push for policy normalization. Furthermore, early signs of Japan's 2026 wage negotiations indicate that wages will once again see strong growth, providing a basis for further rate hikes by the Bank of Japan. Rengo, Japan's largest labor union organization with 7 million members, plans to seek a wage increase of 5% or more in the 2026 wage negotiations. This is the same as their request in 2025, which ultimately resulted in the largest wage increase in 34 years this year. Rate hike butterfly effect to impact global markets again? The hawkish signal released by Ueda Kikuo on Monday drove the yield on the two-year Japanese government bonds, sensitive to monetary policy, to break above 1% on Monday for the first time in 17 years. The warming expectation of a rate hike by the Bank of Japan has triggered a chain reaction in the global fixed income marketon Monday, government bonds, including U.S. Treasury, European bonds, and New Zealand government bonds, all experienced declines. Matt Miskin, Co-Chief Investment Strategist at Manulife John Hancock Investments, stated, "After the Bank of Japan released a hawkish signal for a rate hike in December, the global bond market is experiencing a butterfly effect." The key concern in the market is that as domestic bond yields in Japan rise, Japanese investors may withdraw funds domestically, reducing demand for foreign government bonds. Michael Metcalfe, Head of Macro Strategy at State Street Markets, warned, "The clearer the signs of normalizing Japanese interest rates, the higher the likelihood that Japanese investors will withdraw from or at least reduce purchases of foreign government bonds, weakening a key source of international financing amid soaring sovereign bond issuance." Withdrawing funds from foreign government bonds, including U.S. Treasuries, may push up the yield on the 10-year U.S. Treasury, a "global anchor for asset pricing" with key influence on global risk assets. Additionally, due to the Bank of Japan's long-standing ultra-low interest rate policy, global financial institutions have become accustomed to borrowing yen and then buying other high-yield assets. The scale of these carry trades is as high as $50 trillion. The market is concerned that a rise in Japanese interest rates may lead to a closure of carry trades, reminiscent of the market turmoil in August last year. At that time, the unwinding of yen carry trades caused violent fluctuations in global markets, with the Nikkei 225 index plummeting by 12% in a day. Similar to the current environment, the market saw both the Bank of Japan raising rates and the Federal Reserve cutting rates back then. Some analysts believe that while a repeat of last August's market turmoil is unlikely, there may be similarities. The yen remains a key global funding currency, and once interest rate differentials narrow and the yen strengthens rapidly, highly leveraged carry trade portfolios will be forced to close, with emerging market assets and high-valuation growth stocks often being hit first. There are also views that the likelihood of a repeat of last August's market earthquake is low, but there is a possibility of continued yen strength and rising Japanese bond yields leading to tightening global liquidity, resulting in an increase in global risk-free rates and a decline in prices of liquidity-sensitive assets.