Japan’s liquidity alarm deepens yen-carry unwinding fears, while U.S. rate-cut expectations shift for December

Japan expected to intervene if rates rise
Yen-carry liquidity could evaporate rapidly
U.S. December rate-cut expectations surge

Japan’s potential intervention to defend the yen is raising alarm about a possible liquidity shock across global financial markets. Some analysts warn that if the yen plunges sharply, Japan may sell U.S. Treasuries to secure dollars, a move that could withdraw dollar liquidity from the global system and push U.S. yields higher. As yen depreciation coincides with a surge in Japanese government bond yields, these concerns are intensifying, and expectations for a U.S. rate cut—quiet for months—have begun to resurface.

Signs of escape from zero rates spur sharp yen volatility

According to Barron’s on the 23rd, fears that Japan may tighten liquidity to stabilize the yen have grown rapidly. Societe Generale strategist Albert Edwards said global financial markets “have been addicted for decades to Japan’s ultra-low interest rates and massive quantitative easing,” warning that if Japan “turns off the liquidity tap,” governments across the West, burdened by bloated fiscal deficits, will face severe stress.

At the center of this anxiety lies the unstable yen exchange rate. On the 21st, the yen briefly touched 158 per dollar, approaching the psychological threshold associated with intervention risk. Should Japan intervene, it would likely sell U.S. Treasuries to acquire dollars, instantly withdrawing dollar liquidity from the global system, driving U.S. Treasury yields higher, and raising funding costs for governments worldwide.

Underlying the yen’s weakness is a shift in policy direction. Prime Minister Sanae Takaichi said she would maintain the Bank of Japan’s accommodative stance even at the cost of aggressive deficit spending. Large Japanese life insurers began concluding that, once hedging costs are considered, domestic government bonds now offer more favorable yields than U.S. Treasuries, reducing outward capital flows and driving JGB yields higher. As this dynamic accelerated the yen’s depreciation, Finance Minister Katsunobu Katayama issued verbal warnings signaling readiness to intervene.

These factors suggest that upcoming BOJ rate decisions may carry heavier implications. BOJ Governor Kazuo Ueda recently emphasized that wage gains are spreading from large companies to small and midsize firms and said he will assess supply-side conditions carefully. Yet Japan’s real wages have continued to decline this year, and inflation has remained near 3 percent, leaving a rate hike unsupported by current data. Even so, with Japan signaling determination to exit zero rates, markets broadly view a future rate increase as likely once indicators improve.

Global capital-market volatility deepens

Markets now expect the yen-carry trade to enter an unwinding phase. Yen-carry strategies involve borrowing low-cost yen and investing in higher-yielding foreign assets; they work as long as Japan remains a near-zero-rate economy. But Japan’s bond-market environment has transformed rapidly, with JGB yields hitting their highest levels in 17 years. As a result, borrowing costs and currency-hedging losses are both rising. The yield gap between U.S. and Japanese 10-year Treasuries narrowed from 351.46 basis points early this year to 228.17 basis points by the 21st, reinforcing expectations that yen-carry returns will weaken.

If yen-carry unwinding accelerates, markets in the United States, Europe, and Korea could face immediate pressure. Korea is particularly sensitive due to simultaneous currency weakness and fiscal constraints. Lee Hyo-seop of the Korea Capital Market Institute noted that December and January are traditionally periods when Japanese firms repatriate funds for settlement, adding that rapid rate increases and asset-bubble fears could accelerate unwinding. He also said the pace at which Japan reduces liquidity—through bond issuance and funding operations—will heavily influence global market volatility.

These concerns draw from the shock seen last July, when a BOJ rate hike triggered massive global capital outflows. On August 5, the Nikkei 225 plunged 12 percent, marking its second-largest single-day drop. Korea’s KOSPI and KOSDAQ fell about 8 percent, and the S&P 500 dropped 3 percent, producing a worldwide sell-off. As a result, markets are now focused on whether Japan will adjust its medium- to long-term policy roadmap.

Inflation data delay shifts attention to U.S. rate decisions

In the United States, the possibility of rate cuts—muted in recent months—is resurfacing. The Department of Labor canceled its October Consumer Price Index release due to a government shutdown. The Bureau of Labor Statistics explained that the missing survey data cannot be retroactively collected. The Federal Reserve will therefore lack CPI data for its December FOMC meeting, heightening uncertainty about how policymakers will interpret inflation trends.

New York Fed President John Williams accelerated market speculation after saying at an event in Santiago on the 21st that “near-term rate cuts are possible” as labor-market conditions soften. Following his remarks, the 10-year U.S. Treasury yield fell to 4.063 percent, the lowest this month, and the 2-year yield dropped to 3.507 percent, signaling stronger downward pressure on short-term rates.

The CME FedWatch tool reflected this shift immediately. Market-based expectations of a December rate cut jumped from 39.1 percent on the 20th to 69.4 percent just one day later. The September jobs report—which showed rising unemployment—already strengthened rate-cut sentiment, and the absence of additional inflation data further accelerated these expectations. However, several important indicators remain ahead: weekly jobless claims, retail-related data including Best Buy earnings, and other labor and consumption metrics. These releases could still influence the Fed’s direction in the weeks leading into the December meeting.