US-Japan Policy Divergence: Japan's 80% Interest Rate Hike Implemented, Global Market Fund Flows Shifted?

Original Article Title: "U.S.-Japan Policy Divergence: Japan's 80% Rate Hike Lands, Global Market Money Flow Changes?"

Original Article Author: Xiu Hu, Crypto KOL

In December, the global financial markets were thrust into the spotlight by three acts of "monetary policy drama"—besides the expected Fed rate cut in December (market betting on a 25 basis point cut), the Bank of Japan made a "hawkish" move (BofA warned of a 0.75% rate hike in December, reaching a new high since 1995), and a key change that many overlooked: the Fed officially halted its balance sheet reduction as of December 1, bringing an end to three years of quantitative tightening.

The combination of "rate cut + balance sheet halt" and "rate hike" has completely reshaped the global liquidity landscape: the Fed is stopping "bleeding" on one hand and preparing to "inject liquidity" on the other, while the Bank of Japan is tightening its "purse strings." Between this loosening and tightening, the $5 trillion USD/JPY carry trade faces a reversal, global yield differentials are restructuring rapidly, and the pricing logic of U.S. stocks, cryptocurrencies, and U.S. bonds may be fundamentally altered. Today, we will dissect the impact logic of this event, understand where the money may flow, and uncover where the risks lie.

First, let's highlight: Japan's rate hike is not a "sneak attack"; 80% probability hides these signals

Market participants are now more concerned about "how to hike and what happens after the hike" rather than "whether a hike will occur." According to insiders, Bank of Japan officials are prepared to hike rates at the policy meeting ending on December 19, provided that the economy and financial markets are not significantly impacted. Furthermore, data from the U.S. prediction platform Polymarket shows that the market's bet on a 25 basis point rate hike by the Bank of Japan in December has surged from 50% to 85%, essentially locking in a "high probability event."

The core background of this rate hike lies in two factors:

First, domestic inflation pressure is difficult to alleviate. In November, Tokyo core CPI rose by 3% year-on-year, marking the 43rd consecutive month above the 2% target, and the depreciation of the yen further raised the prices of imported goods;

Second, the economy has found a supportive point. This year, Japanese companies have seen average wage increases of over 5%, a surge unseen for decades, which has provided the Bank of Japan with a foundation to withstand a rate hike. More importantly, Bank of Japan Governor Haruhiko Kuroda had already sent a clear signal on December 1. This "early disclosure" is itself part of the policy—to give the market a heads-up, preventing a repeat of last year's August "unexpected rate hike-induced global stock crisis."

Key Insight: Policy Timing Game, Fund Flows Hold Key Answers

1. Policy Sequence Unpacked: Fed's "First Move," BOJ's "Later Pullback" Logic

Looking at the timeline, the Federal Reserve is highly likely to cut interest rates by 25 basis points in the December rate-setting meeting, while the Bank of Japan plans to follow with a rate hike at the December 19 meeting. This "loose first, tight later" policy combination is not accidental but a rational choice by both sides based on their own economic demands, underlying two key logics:

For the Federal Reserve, the "pause first, then cut rates" combination is a "double defense" against the economic slowdown. In terms of policy rhythm, the halt in balance sheet contraction on December 1st was the first step—this measure ended the quantitative tightening process that had been ongoing since 2022, with the Fed's balance sheet shrinking from a peak of $9 trillion to $6.6 trillion as of November, still $2.5 trillion higher than pre-pandemic levels. The cessation of "bloodletting" aims to ease money market liquidity stress and prevent interest rate volatility stemming from insufficient bank reserves. Building on this, the rate cut is the second step of "proactive stimulus": the November U.S. ISM Manufacturing PMI fell to 47.8, below the growth-neutral threshold for three consecutive months, while core PCE inflation, though receding to 2.8%, and consumer confidence index declining by 2.7 percentage points month-on-month, coupled with the interest pressure from $38 trillion federal debt, the Fed needs to cut rates to lower financing costs and stabilize economic expectations. Choosing to "act first" can seize policy initiative and leave room for potential economic fluctuations.

For the Bank of Japan, "hiking rates with a delay" is a "preemptive adjustment" to mitigate risks. Zhang Zeren, an analyst at West Securities, pointed out that the Bank of Japan deliberately chose to raise rates after the Federal Reserve's rate cut. On the one hand, it can leverage the window of USD liquidity easing to mitigate the impact of its own rate hike on the domestic economy. On the other hand, the Fed's rate cut has led to a decline in U.S. bond yields. At this point, Japan's rate hike can more quickly narrow the U.S.-Japan interest rate spread, enhance the attractiveness of yen assets, and accelerate the inflow of foreign funds. This "riding the trend" operation enables Japan to be more proactive in the process of monetary policy normalization.

2. Fund Absorption Suspicion: Japan's Rate Hike, a Natural "Reservoir" for Fed Rate Cut?

Considering U.S. M2 data and fund flow characteristics, the likelihood of Japan's rate hike absorbing the Fed's liquidity injection funds is high, based on three key facts:

First, the U.S. M2 and policy combination reveal liquidity "double increment". As of November 2025, the U.S. M2 money supply was $22.3 trillion, an increase of $0.13 trillion from October, with November's M2 year-on-year growth reaching 1.4%—this rebound has already shown the impact of halting balance sheet contraction. The dual policy overlay will further amplify the liquidity scale: halting balance sheet reduction implies a reduction of approximately $95 billion in liquidity recycling per month, while a 25 basis point rate cut is expected to release $550 billion in new funds. With both resonating, the December U.S. market will usher in a "liquidity dividend window." However, the issue lies in the continuous decline of domestic U.S. investment returns, with the S&P 500 index's average ROE dropping from 21% last year to 18.7%, a large amount of incremental funds are in urgent need of finding new avenues for returns.

Secondly, Japan's interest rate hike created a "carry trade paradise effect." With Japan raising interest rates to 0.75%, the 10-year Japanese government bond yield has risen to 1.910%, narrowing the spread to the U.S. 10-year Treasury yield (currently 3.72%) to 1.81 percentage points, the lowest level since 2015. For global capital, the attractiveness of yen-denominated assets has significantly increased, especially as Japan, the world's largest net creditor nation, has domestic investors holding $11.89 trillion in U.S. Treasuries. With rising domestic asset returns, this portion of funds is accelerating its flow back, with Japan's net selling of U.S. Treasuries reaching $12.7 billion just in November.

Lastly, the reversal of carry trades and incremental liquidity have formed a "precision handover." Over the past twenty years, the scale of the "borrow yen to buy U.S. Treasuries" carry trade has exceeded $5 trillion, and the liquidity increment from the Fed's "pause + rate cut" combined with the attractiveness of Japanese rate hikes will completely reverse this trading logic. Macro estimates by Capital Economics show that if the U.S.-Japan interest rate spread narrows to 1.5 percentage points, it will trigger the unwinding of at least $1.2 trillion in carry trades, with about $600 billion flowing back to Japan—this scale can not only accommodate the $550 billion in liquidity released by rate cuts but also absorb some of the liquidity retained from balance sheet reductions. From this perspective, Japan's interest rate hike has timely become a "natural reservoir" for the Fed's "loose combination punch": helping the U.S. absorb excess liquidity, alleviate inflationary pressures, and avoid asset bubbles caused by chaotic global capital flows. This kind of "implicit coordination" between policies is worthy of high attention.

3. Global Yield Spread Restructuring: The "Repricing Storm" of Asset Prices

The changes in policy directions and fund flows are driving global asset prices into a repricing cycle, with the distinctive characteristics of different assets becoming more pronounced:

- U.S. Stocks: Short-term pressure, long-term resilience The Fed's rate cut should have been a boon for U.S. stocks, but the carry trade fund outflows triggered by Japan's rate hike formed a hedge. After Haruhiko Kuroda signaled the rate hike on December 1st, the Nasdaq index fell by 1.2% on the same day, with tech giants like Apple and Microsoft dropping by over 2%, mainly because these companies are favored targets of the carry trade funds. However, Capital Economics pointed out that if the rise in U.S. stocks stems from earnings improvements (Q3 S&P 500 component stock earnings grew by 7.3% year-on-year) rather than valuation bubbles, the subsequent decline will be limited.

- Cryptocurrencies: High leverage nature as a "hard-hit area" Cryptocurrencies are a significant destination for carry trade funds, and the liquidity contraction triggered by Japan's rate hike has had the most direct impact on them. Data shows that Bitcoin has dropped by over 23% in the past month, with Bitcoin ETFs experiencing net outflows of $3.45 billion in November, of which Japanese investors' net redemptions accounted for 38%. As carry trades continue to unwind, the volatility of cryptocurrencies will intensify.

- UST: Tug of War Between Selling Pressure and Rate Cut Optimism Japan's fund outflow has led to selling pressure on UST, with the US 10-year Treasury yield rising from 3.5% to 3.72% in November; however, the Fed's rate cuts will boost bond market demand. Overall, the UST yield is expected to maintain a volatile uptrend in the short term, fluctuating in the range of 3.7%-3.9% by the end of the year.

Key Question: Is 0.75% Loose or Tight? Where is Japan's Rate Hike "Endpoint"?

Many fans ask: Is Japan's rate hike to 0.75% considered a tightening monetary policy? Here, a key concept must be clarified — the looseness or tightness of monetary policy depends on whether the interest rate is higher than the "neutral rate" (the rate level that neither stimulates nor restrains the economy).

Kuroda has clearly stated that Japan's neutral rate range is 1%-2.5%. Even if the rate is hiked to 0.75%, it remains below the lower limit of the neutral rate, indicating that the current policy is still in the "loose range." This also explains why the Bank of Japan emphasizes that "a rate hike will not hinder the economy" — for Japan, this is just a shift from "extremely loose" to "moderately loose," and true tightening would require a rate above 1% supported by sustained economic fundamentals.

Looking ahead, Bank of America predicts that the Bank of Japan will "hike rates every six months," but considering Japan's government debt ratio is as high as 229.6% (the highest among developed economies), a rapid hike would increase government interest payments. Therefore, a gradual rate hike is the most likely scenario, with 1-2 hikes per year, each by 25 basis points.

Final Thoughts: Why is Japan's Rate Hike the "Biggest Variable" in December? Key Signals in the Policy Roadshow

Many fans ask, why do we keep saying that Japan's rate hike is the "biggest variable" in the global market in December?

This is not because the probability of a rate hike is low, but because there are three layers of "contradictions" behind it, keeping the policy direction in a vague area of "actionable reconsideration" — until the central bank recently sent clear signals, this "variable" gradually became manageable. In hindsight, from the Bank of Japan's speech to the government's silent approval of the rate hike, the whole process looks more like a "policy roadshow," essentially aimed at resolving the impact of this variability.

The first contradiction is the "inflation pressure versus economic weakness hedge." Japan's Tokyo core CPI rose by 3% year-on-year in November, exceeding the target for 43 consecutive months, pushing for a rate hike; however, GDP fell sharply by 1.8% annually in the third quarter, with personal consumption growth slowing from 0.4% to 0.1%, indicating that the economic fundamentals cannot support aggressive tightening. This dilemma of "controlling inflation yet fearing economic collapse" has kept the market guessing the central bank's priorities, until the signal of over 5% corporate wage increases emerged, providing an "economic support point" for the rate hike.

The second contradiction is the "Conflict between High Debt Pressure and Policy Shift." Japan's government debt-to-GDP ratio is as high as 229.6%, the highest among developed economies. Over the past twenty years, Japan has relied on zero or even negative interest rates to suppress borrowing costs. Once the interest rates increase to 0.75%, the government's annual interest expenditure will increase by over 8 trillion yen, equivalent to 1.5% of GDP. This dilemma of "raising interest rates will worsen debt risk, while not raising interest rates will lead to unchecked inflation" has made policy decisions oscillate. It wasn't until the Fed opened the door to rate cuts that Japan found the buffer space for "opportunistic rate hikes."

The third contradiction is the "Balance between Global Responsibility and Domestic Demands." As the world's third-largest economy and the core hub of a $50 trillion carry trade, Japan's policy changes directly trigger global capital tsunamis. An unexpected rate hike in August last year led to a 2.3% single-day plunge in the Nasdaq index. The central bank not only needs to stabilize the yen exchange rate and mitigate import inflation through rate hikes but also avoid becoming a "black swan" in the global market. The pressure of "considering both domestic and international factors" has kept policy releases in a state of "prudent ambiguity," leaving the market full of speculation about the timing and magnitude of rate hikes.

Due to these three contradictions, Japan's rate hike probability has changed from "50% likelihood" in early November to "85% certainty" now, making it the most difficult-to-predict variable in the December market. The so-called "policy roadshow" involves a gradual statement by Governor Kuroda and the release of insider information to help the market digest this uncertainty step by step. So far, Japanese bond sell-offs, slight yen appreciation, and stock market fluctuations have been within manageable ranges, indicating that this "preventive measure" has begun to take effect.

Today, with an over 80% probability of a rate hike, the variable of "will they or won't they hike" has been largely eliminated, but new variables have emerged—this is also the core issue we continue to focus on.

For investors, the real variables lie in two areas:

One is the post-rate-hike policy guidance—will the Bank of Japan clearly state a "rate hike every six months" rhythm or continue with vague expressions like "based on economic data"?

Two is Governor Kuroda's statements—if he mentions that the "spring 2026 labor negotiations" are a key reference, it means that future rate hikes may slow down; otherwise, they may accelerate. These details are the core code determining fund flows.

On December 19, the Bank of Japan's decision and the Fed's rate cut decision will be announced successively, and the combination of these two major events will reposition global capital. Instead of fixating on short-term ups and downs, we should focus on the core logic of assets: assets with high valuations relying on low-cost funds should be cautious, while assets with solid fundamentals and low valuations may find opportunities in this capital migration.