Why is Japan's interest rate hike so important now? Should we be worried?

Some friends may ask why Japan's rate hike is such a big deal - it's related to the yen being the global market's liquidity provider.

Japan has maintained low interest rates for many years while major Western markets had higher rates, creating a large interest rate differential that enabled carry trades. Many investors borrowed yen to invest globally.

But now as Japan keeps raising rates while the US enters a rate cut cycle, this differential is shrinking. If the Fed cuts 25bps in December while Japan hikes 25bps, the spread would immediately narrow by 50bps - not to mention exchange rate fluctuations.

So not only will new carry trades decrease, existing yen-funded positions may also unwind back to Japan, reducing market liquidity.

Last year we already saw Japan's rate hikes cause short-term market turbulence.

That said, the Fed's rate cuts, QT tapering and potential balance sheet expansion could all help increase liquidity.

So no need to panic yet, but we should still keep an eye on Japan's rate hike situation.

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