BOJ set to raise rates to 1% as yen shorts hit nine-year high

The Bank of Japan is set to raise rates to 1 percent on Tuesday, the highest since 1995, as speculative yen shorts at 115,000 contracts — a nine-year peak — threaten a violent unwind of carry trades that have propped up risk assets globally.

"The large build-up of speculative short positions in the yen raises the risk of a sharp short squeeze if the BOJ signals more aggressive tightening," said Seisaku Kameda, former chief economist at the Bank of Japan.

The decision, the first since December, comes as Japan's wholesale inflation surged to 6.3 percent in May, a three-year high, driven by energy costs from the Middle East conflict. The yen has hovered near 160 per dollar, a level that prompted Japan's Ministry of Finance to spend a record 11.7 trillion yen ($73.12 billion) on intervention in April. Markets are pricing one additional rate increase later this year.

The stakes extend beyond Japan. A stronger yen and rapid unwinding of carry trades — in which investors borrow yen at low rates to invest in higher-yielding assets abroad — could trigger volatility across global equities, bonds, and cryptocurrencies. The setup mirrors July 2024, when a BOJ hike sent bitcoin plunging from roughly $65,000 to $50,000 within a week.

Ueda's Absence Adds Uncertainty

Governor Kazuo Ueda will miss the meeting for hospital treatment of an infected liver cyst, leaving Deputy Governor Shinichi Uchida to brief the media. Uchida, who was himself discharged from hospital last month, is expected to reiterate the BOJ's resolve to continue raising rates while avoiding explicit guidance on timing, according to Kameda. The BOJ's eight remaining board members are seen as mostly favoring the hike, with three having proposed a move to 1 percent at the April meeting.

The Iran peace deal signed Friday, which sent oil prices sliding and global stocks soaring, complicates the BOJ's communication. Lower energy costs could ease inflationary pressure, potentially reducing the urgency for further tightening. "Given the drop in oil prices, the risk for accelerating inflation may weaken," said Masahito Sugawara, a senior strategist at Daiwa Securities. "Market players have been bracing for a hawkish stance from the BOJ, but the post-meeting comments may not be as hawkish as they had expected."

Cross-Asset Transmission Chain

The BOJ's decision lands in a rare week when four major central banks — the Fed, BOE, RBA, and BOJ — all hold policy meetings. The Federal Reserve, now chaired by Kevin Warsh in his first FOMC meeting, is widely expected to hold rates steady at 5.25 percent to 5.5 percent, unchanged since July 2023. The Bank of England is also expected to hold. Brazil's central bank stands alone in cutting, expected to lower its benchmark from 14.5 percent.

For currency markets, the key variable is whether Uchida's tone satisfies expectations for further tightening. If the BOJ delivers the expected hike but signals caution, yen bears may be emboldened, pushing dollar-yen back toward 161 — a level that could trigger more intervention. If Uchida strikes a more hawkish tone, the yen could strengthen sharply, unwinding the record short positions and sending shockwaves through risk assets.

The last time the BOJ used similarly hawkish language was in July 2024, when it raised rates and signaled further tightening. The yen surged, the Nikkei dropped 12 percent over two weeks, and bitcoin lost 23 percent of its value. With yen shorts now even larger than they were then, the potential for a repeat — or worse — is real.

This article is for informational purposes only and does not constitute investment advice.