The $500 billion "dark gamble" behind the yen's decline: Why does raising interest rates instead trigger market greed?

Rising Rates but Depreciation: The Market’s “Psychological Warfare”

Last Friday, Bank of Japan Governor Kazuo Ueda announced an increase in the policy interest rate to 0.75%—the first time since 1995 that this level has been reached, which should have triggered a sharp rise in the yen. But the actual market response was completely opposite.

After the announcement, USD/JPY slid from the 155 range down to 157.43. The yen not only failed to appreciate but showed a typical “profit-taking and cashing out” pattern. Wall Street sent a clear signal through market voting: we bet you won’t dare to raise rates again.

Why does the market dare to ignore hawkish signals?

Arbitrage trading remains the dominant force

According to Morgan Stanley’s latest statistics, there are still about $500 billion in open yen carry trades worldwide. These funds borrow cheaply in yen and invest in US tech stocks, emerging markets, and cryptocurrencies.

Counterintuitively, even if the yen interest rate rises to 0.75%, compared to the US dollar’s 4.5%+ rate, the interest rate differential remains as high as 375 basis points. As long as volatility (VIX) stays low, arbitrageurs will ignore the increased borrowing costs and even continue to add positions. ING forex strategist admitted that the market is actually betting on a deeper assumption: Ueda Kazuo will not raise rates further before June 2026.

The result? The yen’s decline has become a vivid illustration of this “cowardly game.”

Cryptocurrencies feel the liquidity tightening first

Unlike the relatively calm traditional stock markets, the most liquidity-sensitive crypto market has sounded the alarm first. After the rate hike confirmation, Bitcoin (BTC) quickly dropped from above $91,000.

According to the latest market data, BTC is currently fluctuating around $94.10K (with some retracement pressure compared to before the rate hike). Historical patterns show that after Japan’s last three rate hikes, Bitcoin experienced 20%-30% swings. If yen carry trades unwind massively in the coming weeks, Bitcoin could face deeper downward testing, with $85,000 becoming a key support level.

Hidden risks in the US bond market

More concerning than the yen’s depreciation is the change in the US bond market. After the rate hike, Japanese institutional investors (one of the largest holders of US Treasuries globally) are facing dual temptations of exchange rate losses and rising interest rates. As a result, the US 10-year Treasury yield broke through 4.14%.

This phenomenon is called “bear steepening”—long-term yields rise not because of overheating economy but due to the retreat of major buyers (Japanese capital). This will directly increase the financing costs for US companies and exert long-term, hidden pressure on US stock valuations by 2026.

The “speed race” of 2026: who raises rates, who cuts, and the market’s future pattern

By 2026, the global financial landscape will be decided by a race against time.

Optimistic scenario: The Federal Reserve slowly cuts rates to 3.5%, while the Bank of Japan holds steady. The interest rate differential remains wide, with $500 billion in arbitrage continuing, leading to a win-win for US and Japanese stocks, and USD/JPY staying above 150.

Pessimistic scenario: US inflation rebounds, forcing the Fed to halt rate cuts; Japan’s inflation spirals out of control, prompting the BOJ to aggressively raise rates. The economic model of arbitrage quickly collapses, with $500 billion fleeing in a stampede, the yen soaring to 130, and global high-risk assets crashing.

Currently, market pricing fully favors the first scenario. But Goldman Sachs warns that if USD/JPY hits the psychological level of 160, the Japanese government is very likely to intervene, and the resulting “artificial volatility” could trigger the first wave of large-scale deleveraging.

Three key indicators to determine your response rhythm

Monitor the 160 level: This is the red line for potential intervention by the Japanese government. If the yen falls below this threshold, market volatility will spike sharply, and shorting the yen will become extremely risky.

Bitcoin support at $85,000: Cryptocurrencies have become the leading indicator of global liquidity. If BTC falls below this level, it indicates institutional withdrawal from the highest-risk assets, signaling the start of a risk-avoidance cycle.

The trend of real yields on US Treasuries: Morgan Stanley’s 2026 outlook emphasizes that rising financing costs will trigger a major rotation—funds will shift from high-valuation, low-cash-flow tech stocks to defensive sectors like industrials, consumer staples, and healthcare. The speed of this rotation directly reflects the market’s confidence in Federal Reserve policies.

Risk warning for Taiwanese investors

The New Taiwan Dollar will face dual shocks from US dollar strength and yen carry unwinding, potentially pushing exchange rate volatility to recent highs. Companies holding yen-denominated debt or with significant US revenue should proactively hedge.

If global liquidity tightens rapidly, high P/E Taiwanese tech stocks will come under pressure. Especially those heavily reliant on overseas financing and highly correlated with US tech stocks, they may experience significant adjustments. In this environment, high-dividend Taiwanese stocks, utility sectors, and short-term USD bond ETFs will stand out for their defensive value.