Back-to-back Bank of Japan hikes are really about the yen

The Bank of Japan could raise interest rates at three consecutive meetings through December, according to Nomura, a securities house: a quarter-point in September, then back-to-back moves in October and December. A printing of that forecast reads like a victory lap for monetary tightening. It is better read as a rescue operation for a currency — and a sign that the bargain keeping Japanese money cheap for a quarter of a century is approaching its limit.

Start with the numbers that make the yen the world's favourite funding currency. The BOJ's policy rate stands at 1.0%, raised in June from the negative territory it inhabited for most of the past two decades. American short rates sit between 3.5% and 3.75%. That gap of more than two and a half percentage points underpins the carry trade, in which investors borrow the cheap yen and park the proceeds in higher-yielding dollars. It is the same gap that pushed the yen close to a 40-year low above 160 to the dollar this summer. Nomura's three-hike scenario is explicitly contingent on the currency staying weak: it applies if dollar-yen trends toward 160, not if it recovers.

To see why that is the condition, notice who wins and who loses from a weak yen. A cheap yen is not a market accident; it is a policy embedded in the interests of export and banking giants and of a government that likes cheap money. Prime Minister Sanae Takaichi is dovish, and her government's blessing matters because the BOJ, unlike the Federal Reserve, is meant to act in step with it. The bill for the weak yen is paid by Japanese households, who import food and fuel priced in dollars. Hence inflation has exceeded the BOJ's 2% target for much of the past four years, and the central bank, described by Fitch, a ratings agency, as needing further rate rises to deliver any durable yen appreciation, has spent that whole period chasing the curve.

The tell that the system is straining is the price of propping the currency up without higher rates. Tokyo, the American Treasury and South Korea intervened jointly in late July and early August, spending a record ¥15.4 trillion to buy yen. It worked only briefly: the currency slipped back above 159, then leapt to a one-month high near 156 this week on the very rate-hike bets Nomura is describing. Intervention without higher rates is bailing a boat with a sieve. That is why the market has priced the first move so aggressively — a September hike went from a 24% chance on July 30 to more than 80% within a month, with a second fully priced by January.

The forecast therefore does not require believing in a suddenly militant BOJ. It requires believing that the authorities have run out of cheaper ways to defend the yen. Even so, Nomura calls three straight hikes an extreme case; its base case is merely one hike a quarter, and economists polled by Bloomberg mostly expect a single move by December, taking the rate to around 1.75% before the cycle tops out. The distance between those two paths is the whole question.

That question reaches a dollar-based portfolio through a pair of familiar ETFs. Your standard unhedged Japan fund, such as the iShares MSCI Japan ETF (EWJ), quietly fuses two bets: one on Japanese corporate returns, one on the yen's direction. A currency-hedged fund such as the WisdomTree Japan Hedged Equity Fund (DXJ) strips the currency out — and today it is the comfortable version, because the same yield gap means dollar investors are paid to hedge. But that comfort is precisely what the BOJ's path is meant to erode: as rates converge, the yen firms and the hedge's free lunch shrinks. The unhedged investor, meanwhile, would finally be repaid for years of currency drag if the yen sustains its recovery — yet that recovery is what squeezes exporters, whose overseas profits lose yen value when the currency strengthens.

The summer of 2024 shows how violent that fork can be. Then, a surprise BOJ hike and currency intervention triggered a 24% peak-to-trough fall in the TOPIX index, with exporters and financials hit hardest. Goldman Sachs notes that foreign positioning in Japanese equities is now 20% above pre-2024 levels and hedge-fund allocations sit near five-year highs — the ingredients for a sharper unwind this time if the yen firms faster than expected.

So watch the yen, not the meeting calendar. Nomura's back-to-back scenario is a contingency, not a promise, and it hinges on exactly one thing breaking: the yen trending back toward 160, forcing the BOJ's hand. The deeper tension is which side of the old bargain gives first — the households eating imported inflation, who are being asked to fund the exporters' subsidy, or the exporters and the state that have grown dependent on a currency that no longer needs to be that cheap. A recovery in the yen is the moment the bill for a cheap currency finally comes due, and it will not be paid without argument.