Why Businesses Should Pay Attention To International Monetary Policy

Zain Jaffer is the founder and president of Zain Ventures, a family office that invests in real estate and proptech.

In late July 2024, the Bank of Japan (BOJ) raised interest rates to around 0.25%, from an earlier range that ran for years between zero to 0.1%. This has been the case since 2008, when their rate was around 0.3%. In addition, the BOJ said that it would cut their monthly purchases of Japanese government bonds to around 3 trillion yen ($19.64 billion) monthly in the January to March 2026 quarter.

Like the U.S. Federal Reserve, Japan is trying to prevent inflation from rearing its ugly head in a country that is not used to it by making debt slightly more expensive, thus slightly reducing the amount of money circulating.

The BOJ will likely not approach the levels of U.S. interest rates because their inflation is lower, and because for the past few years, they have been encouraging borrowing by businesses to spur their economic recovery. However, this slight reduction in their money supply resulting from both a small rate hike and more BOJ quantitative tightening (buying of bonds to release more cash to banks) caused the supply of yen to lessen relative to demand, thus strengthening their currency.

The Yen And International Trade

This impacts the U.S. dollar to Japanese yen conversion rate by effectively lowering the dollar versus yen slightly. This would mean that Japanese imports to the U.S., like Toyota, Honda and other Japanese products and services, will be slightly more expensive for Americans.

Again, the BOJ will likely not overdo it, lest it run the risk of making Japanese goods and services too expensive for the global market, and thus threaten their own manufacturing industries.

One impact, though, of this BOJ rate hike is that Japanese debt is effectively no longer free (or almost free) from an interest perspective. One may argue that 0.25% is such a small amount, but take note that it is an overnight lending rate, not an annual one.

If the BOJ continues this trend and keeps raising the rate and also effectively making the yen more expensive compared to the dollar, then foreign borrowers will likely take pause. Aside from having to pay a small interest, they also have to buy more expensive yen that is rising to pay back the debt which is denominated in Japanese currency.

The Japan Carry Trade

One of the most affected practices from this development is what is called the Japan carry trade. A carry trade is one where a borrower borrows from a low interest rate lender to buy assets that yield more. The trader earns from the difference or spread.

If the spread was low to begin with, the trader might find that there is no more sense in continuing and will likely “unwind” the carry trade. This means that if they feel that the debt is becoming more expensive, they will close it by paying it back. These borrowers originally wanted to keep the spread between what they owe and what they earn from these riskier assets, but the interest rate hikes make the spreads (price differences) no longer worth it.

In the case of the Japan carry trade unwind, the trader will sell the assets they bought to pay their Japanese debt before it becomes more expensive.

The Business Impact

So how exactly does this impact Americans? Aside from impacts on the balance of trade and other effects, it also affects the U.S. stock markets. Basically what has been happening during the past few years is that traders would borrow from Japan because the interest rate on the debt was almost zero, and buy riskier but profitable assets that yield higher than the Japanese effective interest rate. So effectively, those buyers have to sell and pay off their Japan debts before it becomes too expensive with rate hikes.

The BOJ, after seeing the massive global turmoil of their interest rate hike, initially decided not to move further. But since they also need to protect their own domestic market from inflation, they have not ruled out further hikes.

This can affect businesses in different ways. For example, companies that rely on Japanese imports, whether for finished goods (e.g., Toyota, Honda, etc.) to resell in the U.S. or for key components, have to pay a higher cost if the value of the yen to the U.S. dollar goes higher. Likewise these same Japanese companies that need to finance their operations have to raise their prices due to the higher cost of debt.

U.S. companies that want to sell to the Japanese market (e.g., GM, Ford) could see increased sales because their items are cheaper than before. It mainly impacts those companies that need Japanese yen for their businesses, either to buy or sell products and services, or to pay or avail of debt financing.

Plus the sudden sell-off of stocks can affect the market cap of U.S. companies, of course, with all the global impacts that market volatility brings.

Staying Informed

What this demonstrates is we live in such an interconnected world that a small development from another corner of the world impacts us almost at the speed of news. Our global economies are so interconnected, from supply chains, to currencies, to policies and others. Business leaders, entrepreneurs and investors need to educate ourselves on these factors, with the Japan carry trade being one of those things we need to know about.

It is virtually impossible to know everything political, social, economic, cultural and technical that can affect the business and finance world. Also we tend to assume that when things are set, such as the Japan carry trade, that it will continue unabated for some time, which no longer seems to be the case. Many less sophisticated investors for example did not know about the carry trade, and even those who did were not expecting the sudden turmoil of the BOJ announcement.

The only thing we can do is to keep abreast of most developments and hope we make the right decision even if our information is incomplete most of the time.

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