Decades of practically ‘free money’ from Tokyo are now coming to an end

​For decades, the global financial system has relied on several rock-solid anchors. One of those is the Bank of Japan (BOJ). 

While the rest of the world has been grappling with inflation and major fluctuations in interest rates, Japan remained, for all intents and purposes, at zero – providing an endless supply of cheap liquidity for global investors. 

Their rate has now crept up, with the BOJ’s recent decision to raise the rate to 0.75% – the highest level in three decades. 

Are we are witnessing the final dismantling of the world’s last ultra-loose monetary regime?

​The impact of this shift extends far beyond Tokyo’s stock exchange. It fundamentally alters the plumbing of global finance, primarily through the unravelling of the “Yen Carry Trade.”

​How the ‘Yen Carry Trade’ unwinds

​For years, the carry trade was the closest thing to a free lunch in global finance. Investors would borrow Japanese yen at rock-bottom interest rates and invest that money in higher-yielding assets abroad, such as US Treasuries, Mexican Pesos or tech stocks. This flow of capital acted as a subsidy for global asset prices.

​As Japan hikes rates, the arbitrage becomes less, especially as the US lowers rates. Borrowing in yen is no longer virtually free. As the cost of servicing these loans rises, investors are forced to sell their foreign assets to pay back their yen debts. 

We saw a preview of this danger in August 2024, when a hawkish signal from the BOJ triggered a brief but violent global market sell-off. The current tightening cycle ensures that this liquidity drain is not a temporary blip, but a deliberate structural change.

​The repatriation of Japanese capital

​Perhaps the most significant long-term consequence is the repatriation of Japanese capital. Japanese institutional investors, pension funds, insurers and banks are among the largest holders of foreign debt in the world. They own over $1 trillion in US government bonds alone.

​For years, these institutions were forced to send their money overseas to find any yield at all. Now, with domestic 10-year Japanese Government Bond (JGB) yields climbing toward 2%, the incentive to take risks abroad is vanishing. 

If Japanese investors begin to sell their US or European bonds to bring that money home, it will drive up borrowing costs for governments across the West. The US and Europe may soon find that the reliable buyer they counted on for decades has left the auction house.

​Currency and competitive pressure

​The hike also marks a turning point for the currency markets. A perpetually weak yen has historically boosted profits for Japanese corporate giants like Toyota and Sony by making their exports cheaper abroad. A tightening monetary policy strengthens the yen, squeezing these profit margins.

​However, a stronger yen also reduces the cost of imports for Japan – critical for a nation that imports almost all its energy. This could stabilise Japan’s domestic economy, even if it creates headwinds for its stock market.

​The new normal

​The BOJ’s move to 0.75% is not just a rate adjustment. It signals a regime change. It signals that the era of synchronised global liquidity is over. Central banks in the US and Europe are already navigating a “higher for longer” environment and Japan has removed the last release valve for cheap capital.

​For the global economy, the immediate risk is volatility as trillions of dollars in carry trades are unwound. But the longer-term reality is tighter financial conditions everywhere. The cheap money that fuelled asset bubbles from Silicon Valley to emerging markets is drying up at the source. 

The world must now learn to operate without the Bank of Japan’s subsidies.

​NOTE: This is the view of this columnist and should not in any way be seen as independent investment advice.