How the Bank of Japan’s Interest Rate Hike Could Affect US Investors

Key Takeaways

• The Bank of Japan ended its negative interest rate policy, paving the way for the first interest rates since 2007.
• Rate hikes in Japan could impact U.S. investors, creating a knock-on effect that would pressure U.S. Treasurys if Japanese investors were to pull money out.
• Japanese investors are the largest foreign holders of U.S. Treasurys.

For the first time in nearly two decades, the Bank of Japan removed negative interest rates Tuesday, which could signal potential pressure on U.S. Treasurys.

The Bank of Japan (BOJ) announced it was ending its use of “yield curve control,” a measure that ends the negative interest rates that central bankers used to try to boost the country’s stagnant economy. Ending negative rates paves the way for the central bank to institute its first interest rate hike since 2007.

The BOJ’s move today could have a “knock-on effect” on U.S. investors, especially if more Japanese investors start acting on the positive rates at home.

Many Japanese investors have borrowed yen at low rates to buy higher-yielding U.S. Treasurys, a practice commonly called a “carry trade,” during this period of negative interest. But with the Bank of Japan pushing interest rates higher in Japan, that trade won’t work as effectively and some investors could bring that money back home. 

“Given that Japanese institutional investors are the largest foreign holders of treasuries, central bank activity in the U.S. and Japan is important,” wrote Quincy Krosby, LPL Financial’s chief global strategist. “Concerns are rising that due to greater Treasury funding needs, Japanese flows from treasuries could be repatriated toward rising yields in Japanese bonds, especially if Treasury yields edge lower as inflation eases.”

Lower Demand for U.S. Treasurys Could Send Yields Higher

Fewer Japanese buyers of U.S. Treasurys could help send those yields higher because fewer people would be in the market for Treasurys.

Higher Treasury yields could, in turn, send interest rates higher. That would make loans more expensive for all sorts of borrowers in the U.S. For example, higher Treasury yields could push mortgage rates higher.

“Mortgage rates generally track the rate on 10-year Treasury bonds because both instruments are long term and because mortgages have relatively stable risk,” wrote Brookings Institute economists Wendy Edelberg and Noadia Steinmetz-Silber.

The Impact Wouldn’t Just Be in the U.S.

One reason that the BOJ’s move could be felt by investors in the U.S. is due to the large amount of assets that Japanese investors hold in overseas investments, totaling around $3 trillion according to the International Monetary Fund.

“Although the U.S. has the largest economic influence in the world, Japan may have the largest influence in the asset markets due to these account surpluses,” wrote Jeffrey Kleintop, Charles Schwab managing director and chief global investment strategist. “Should the BOJ begin to substantially tighten monetary policy, the potential for a reversal of decades of outward flow of capital may be felt by investors worldwide.”

Read the original article on Investopedia.