Besen te stated, "I am the dealer"! Expectations for a rate hike by the Bank of Japan have surged, but the yen's rising momentum faces the risk of unmet expectations.

U.S. Treasury Secretary Ben S. Bernanke has recently intensified public pressure on Japan to tighten its monetary policy and has frequently sent strong signals supporting the yen, rapidly raising market expectations for the Bank of Japan's future interest rate hike path. As investors have almost entirely bet on the Bank of Japan raising rates by 25 basis points next week, some market players have even begun discussing the possibility of a one-time 50 basis point hike or a series of consecutive hikes. Analysts warn that if the hawkish signals ultimately released by the Bank of Japan fail to meet the significantly elevated market expectations, the yen's recent gains could quickly reverse and introduce new volatility into the global financial markets. On Tuesday, Bernanke further reinforced these expectations at an event at Southern Methodist University in Texas. The U.S. Treasury Secretary, who has a long history in hedge fund trading, claimed to possess "asymmetric information" regarding the Bank of Japan's next moves and stated, in market trading terms, that he is now the "house." Bernanke not only spoke about the Bank of Japan but also suggested that he understands the next moves of Japan's policymakers. Although he did not explicitly state what specific actions he hopes the Bank of Japan will take, just last week he publicly urged Japanese officials to "do the right thing" regarding interest rates. This series of statements has heightened market attention on the Bank of Japan's September meeting. The market has already priced in the expectation of a 25 basis point hike next week, so what could truly impact the market may no longer be just "whether to raise rates," but whether Bank of Japan Governor Kazuo Ueda will convey a sufficiently strong signal indicating a further acceleration of monetary policy normalization. Seisaku Kameda, a senior economist at Sompo Institute Plus and former chief economist at the Bank of Japan, stated that Bernanke has pushed market expectations "too far." Some investors have even begun betting on the possibility of a one-time 50 basis point hike by the Bank of Japan or a series of consecutive rate increases. Kameda believes these expectations have become excessive and may need to be revised downward in the future. If the Bank of Japan's actual actions fall short of the current high market expectations, there is a risk that the yen could weaken again. If the Bank of Japan raises rates again next week, it will mean a cumulative total of three rate hikes within 12 months, marking the fastest tightening cycle in over three decades. Although officials at the Bank of Japan have indicated that future rate increases may occur more frequently than the roughly six-month intervals observed in the past, policymakers still wish to retain enough flexibility and are reluctant to commit to a fixed rate hike path in advance. This also puts Kazuo Ueda in a progressively delicate position regarding policy balance. On one hand, since Prime Minister Sanae Takaichi took office, there has been caution against hastily increasing rates, coupled with a push for a large-scale fiscal expenditure plan, where lower financing costs are clearly more beneficial for this policy direction; on the other hand, Bernanke's ongoing public calls for Japan to raise interest rates require Tokyo to consider policy coordination with the United States. Bernanke's high level of involvement in Japan's monetary policy is not sudden. Japan remains the largest overseas holder of U.S. Treasury securities, and narrowing the U.S.-Japan interest rate differential to prevent further depreciation of the yen has become a recurring concern for Bernanke over the past few months. At the end of July, Bernanke coordinated with Japans Finance Minister Shunichi Suzuki to implement the first joint U.S.-Japan intervention in the currency market since 1998, jointly buying yen to prevent continued depreciation after the yen had dropped to about a 40-year low. However, in terms of actual funds deployed, the scale of U.S. direct intervention was relatively limited. According to estimates by former U.S. Treasury official Brad Setser, the actual amount the U.S. invested at that time was likely only about $500 million, significantly lower than the $5 billion to $10 billion yen buying plan Bernanke previously presented to reporters. In contrast, Japan contributed approximately $96 billion to stabilize the yen lately, setting a record. The real impact has instead come from Bernanke's persistent verbal interventions. Since the joint U.S.-Japan action, he has frequently publicly warned investors not to bet on the yen's decline and has consistently reinforced the view that Japan needs to raise interest rates. Driven by this series of comments, the yen has recently risen above 154 yen per dollar, even surpassing a level that had not been reached during the earlier U.S.-Japan joint intervention. On Wednesday morning in New York, the yen traded at about 153.16 yen to the dollar at one point. From the perspective of the Bank of Japan, Bernanke's statements are not entirely negative. Harumi Taguchi, chief economist at S&P Global Market Intelligence, believes that the Bank of Japan might actually welcome these comments, as the bank itself hopes to steadily advance monetary policy normalization, and pressure from the U.S. can help build domestic consensus in Japan in support of normalization. But the issue is that Bernanke's "verbal intervention" may be too successful. As the yen appreciates rapidly and market expectations for the Bank of Japan to raise interest rates continue to rise, the carry trade, which has been long built on Japan's ultra-low interest rates, faces the risk of unwinding. Such trades typically involve borrowing yen at low costs and reinvesting in higher-yielding assets in overseas markets like the United States. This strategy is especially profitable when the yen continues to depreciate; however, once the yen appreciates rapidly, the trades may quickly reverse. Similar risks have already emerged in 2024. At that time, a policy tightening by the Bank of Japan that exceeded some investors' expectations triggered a rapid unwinding of global carry trades, resulting in severe fluctuations in the Japanese stock market, with the Nikkei index experiencing a single-day drop of 12.4% at the height of the market turbulence, marking the largest single-day percentage decline since the "Black Monday" in 1987. Taro Kimura, a senior economist for Japan at Bloomberg Economics, pointed out that yen carry trades perform exceptionally well when the yen is depreciating, but a rapid appreciation of the yen may also lead to severe reversals. He warned that Bernanke's direct intervention in expectations for the Bank of Japan's policies is, in fact, "playing with fire." The risks facing next week's Bank of Japan meeting have changed. The market now not only requires the bank to raise rates by 25 basis points but also begins to expect a faster and more aggressive subsequent tightening path. After Bernanke continually raised market expectations, even if the Bank of Japan raises rates as expected, it may not be sufficient to satisfy investors. If Kazuo Ueda does not release clear signals of further consecutive rate hikes, the yen may come under pressure again due to unmet expectations; yet, if the central bank behaves too hawkishly, it could lead to a rapid appreciation of the yen and trigger concentrated unwinding of carry trades, further transmitting the impact of Japan's monetary policy onto global equity, debt, and currency markets.