After the rate hike, the yen depreciated again, and the $500 billion arbitrage position is still "betting" on the central bank retreating

Last Friday, the Bank of Japan raised interest rates to 0.75%, a 30-year high, which should have boosted the Japanese Yen. However, the market played in the opposite direction—USD/JPY broke through 157.4, and the Yen depreciated instead. The reason is simple: Wall Street doesn’t believe the Bank of Japan dares to raise rates aggressively.

Signs of Liquidity Tightening Emerge, Crypto Markets Lead the Losses

The most sensitive signal comes from Bitcoin. After the rate hike announcement, BTC quickly dropped from $91,000 to around $87,020, a nearly 3% decline in one day. Historical data shows that after the Bank of Japan raised rates three times in the past, Bitcoin experienced 20%-30% swings.

Why are cryptocurrencies the “canary in the coal mine” for liquidity? Because they attract the world’s most aggressive arbitrage capital. Yen arbitrage positions borrow cheap Yen and flood into Bitcoin, US tech stocks, and emerging markets. Once liquidity begins to tighten, these high-risk assets are the first to suffer.

$500 Billion Unwinding Trap

According to Morgan Stanley estimates, approximately $500 billion of Yen arbitrage trades remain open globally. The logic behind these trades is that even if the Yen rises to 0.75%, the interest rate differential compared to the USD’s 4.5%+ remains attractive.

The issue is that the market is betting that Ueda and the Bank of Japan won’t continue to raise rates aggressively. Traders generally expect the next rate hike to be in June 2026. As long as Yen appreciation is slow, arbitrageurs will choose to “sit tight” or even add to their positions. ING FX strategists note that as long as volatility remains low, the market will ignore the additional 0.25% cost.

But the risk in this gamble is that if volatility suddenly spikes or the Bank of Japan unexpectedly accelerates rate hikes, this $500 billion could exit in a stampede.

Rising U.S. Treasury Yields Will Increase Corporate Financing Costs

More concerning than the Yen exchange rate is the change in the U.S. Treasury market. After the rate hike, Japanese institutional investors (one of the largest holders of U.S. Treasuries) are beginning to face return flow temptations. The 10-year U.S. Treasury yield has surged to 4.14%, and this “long-end yield rise” directly increases corporate financing costs.

This exerts invisible pressure on the valuation of risk assets in 2026, especially high P/E, low cash flow tech stocks.

The True Test in 2026: Speed Race

The upcoming scenario depends on the “Federal Reserve rate cut speed vs. Bank of Japan rate hike speed” game.

Most optimistic scenario: The Fed slowly cuts rates to 3.5%, while the Bank of Japan holds steady. The interest rate differential remains accommodative, arbitrage trading continues to thrive, the Yen remains weak, and USD/JPY stabilizes above 150.

Most pessimistic scenario: U.S. inflation rebounds, forcing the Fed to halt rate cuts; Japanese inflation spirals out of control, prompting the BOJ to accelerate rate hikes. The $500 billion arbitrage positions exit in a stampede, USD/JPY surges to 130, and global risk assets crash.

Goldman Sachs warns that if USD/JPY hits the 160 psychological level, the Japanese government is very likely to intervene in the foreign exchange market, and the resulting “artificial volatility” could trigger the first wave of large-scale deleveraging.

Three Key Risk Indicators to Monitor Closely

Critical support at 160: If USD/JPY hits 160, the risk of foreign exchange intervention is extremely high. Do not blindly short the Yen.

Bitcoin $85,000 support line: Cryptocurrencies have become the leading indicator of global liquidity. If BTC falls below this support, it indicates institutional investors are withdrawing liquidity from the highest-risk assets, usually signaling the start of a risk aversion cycle.

10-year Treasury yield trend: As financing costs rise, funds will rotate from high-valuation tech stocks to defensive sectors like industrials, consumer staples, and healthcare. The speed of this sector rotation directly reflects market confidence in the Fed’s policy.

Currently, market pricing fully favors the Bank of Japan holding steady, which explains why the Yen depreciated after the rate hike. But if expectations reverse, the market will face a fierce liquidity tightening shock. Investors should proactively hedge risks.