Will Japan's interest rate hike trigger a global liquidity shock?

As the Bank of Japan's monetary policy meeting on December 19 approaches, market concerns about a potential hawkish interest rate hike are intensifying. Will this move end the era of cheap yen and trigger a global liquidity crisis? Western Securities released a detailed analysis in its latest strategy report on December 16.

High Inflation, Japan's Hawkish Rate Hike is Inevitable

The report points out that there are multiple driving factors behind the Bank of Japan's potential interest rate hike. Firstly, Japan's CPI has consistently exceeded the official inflation target of 2%. Secondly, the unemployment rate has remained below 3% for a long time, creating favorable conditions for nominal wage growth, and the market has high expectations for wage increases in next year's "Shunto" (spring labor negotiations), which will further increase inflationary pressure. Finally, the 21.3 trillion yen fiscal policy introduced by high-ranking officials may also exacerbate inflation.

These factors collectively force the Bank of Japan to adopt a more hawkish stance. The market is concerned that once the interest rate hike is implemented, it will lead to a concentrated unwinding of a large number of "carry trade" positions accumulated during Japan's YCC (Yield Curve Control) era, thereby impacting global financial market liquidity.

Theoretical Analysis: Why the Most Dangerous Phase of Liquidity Shock May Have Passed?

Despite market worries, the report analyzes that, theoretically, the current interest rate hike in Japan has a limited impact on global liquidity.

The report lists four reasons:

1. Risk Has Been Partially Released: The Bank of Japan has raised interest rates three times since last March. Among them, the rate hike in July last year, combined with the exit from YCC, did indeed cause significant liquidity shock, but the impact of the rate hike in January this year has clearly weakened, indicating that market adaptability is increasing.

2. Speculative Positions Have Exited Early: Data from the futures market shows that most speculative short positions on the yen were closed last July. This means that the most active and likely to trigger chain reactions "carry trades" have already receded, and the most dangerous phase of liquidity shock has passed.

3. Different Macroeconomic Environment: Currently, the U.S. is not experiencing a "recession trade" similar to that of last July, and there is little pressure on the dollar to depreciate, while the yen itself is weak due to geopolitical and debt issues. This weakens expectations for yen appreciation, thereby alleviating the urgency of unwinding "carry trades."

4. The Federal Reserve's "Safety Net": The report specifically mentions that the Federal Reserve has begun to pay attention to potential liquidity risks and has initiated balance sheet expansion (similar to QE) policies, which can effectively stabilize market liquidity expectations and provide a buffer for the global financial system.

Actual Risks: "Catalysts" in a Fragile Market

The report emphasizes that theoretical safety does not equate to being worry-free. The current fragility of the global market is the real root cause of the potential shock triggered by Japan's interest rate hike. The report describes it as a "catalyst."

The report analyzes that the significant impact of Japan's interest rate hike last July was due to the resonance of two major factors: "a large number of active carry trade positions being closed" and "the U.S. recession trade." Currently, the conditions for the former have weakened. However, new risks are emerging: the global stock market, represented by U.S. stocks, has experienced a 6-year "bull market," accumulating a large amount of profit-taking positions, which creates fragility. At the same time, concerns about the "AI bubble theory" in the U.S. market have resurfaced, leading to strong risk-averse sentiment among investors.

However, the current global stock market, represented by U.S. stocks, has already been in a 6-year "bull market," which itself has fragility. Additionally, concerns about the "AI bubble theory" in the U.S. have resurfaced, leading to a heavy risk-averse sentiment. The yen's interest rate hike could potentially become a "catalyst" for triggering a global liquidity shock.

In this context, Japan's interest rate hike, a certain event, could very likely become a trigger, causing panic outflows of funds and thus inducing a global liquidity shock. However, the report also provides a relatively optimistic judgment: this liquidity shock will likely force the Federal Reserve to implement stronger easing policies (QE), and therefore, the global stock market may quickly recover after a brief sharp decline.

Watch More, Act Less: Focus on "Triple Kill" Signals in Stocks, Bonds, and Currencies

In the face of this complex situation, the report advises investors to "watch more and act less."

The report believes that since the Bank of Japan's decision is basically a "clear signal," but the choices of funds are difficult to predict, the best strategy is to maintain observation.

• Scenario One: If there is no panic outflow of funds, the actual impact of Japan's interest rate hike will be very limited, and investors do not need to take action.

• Scenario Two: If panic among funds indeed triggers a global liquidity shock, investors need to closely monitor a key signal—whether the U.S. market experiences 2-3 consecutive instances of "triple kills" in stocks, bonds, and currencies (i.e., simultaneous declines in the stock market, bond market, and currency market). The report points out that if a situation similar to early April of this year reoccurs, it would indicate a significantly increased probability of a liquidity shock in the market.

Finally, the report believes that even if Japan's interest rate hike causes turmoil in the short term, it will not change the long-term trend of global monetary easing. In this context, it continues to be optimistic about the strategic allocation value of gold. At the same time, with the expansion of China's export surplus and the Federal Reserve restarting interest rate cuts, the renminbi exchange rate is expected to return to a long-term appreciation trend, accelerating the return of cross-border capital and benefiting Chinese assets. The report is optimistic about AH shares experiencing a "Davis Double Hit" in profits and valuations The report holds a volatile outlook for U.S. stocks and U.S. bonds