Will the Bank of Japan's December hawkish rate hike? Arbitrage traders are already starting to panic

Hiking Interest Rates on the Horizon, Market Divided

Bank of Japan Governor Ueda Kazuo will make a statement next week. The December 19th interest rate decision has already become a “time bomb” for the global financial markets. The consensus expects a 25 basis point hike to 0.75%, hitting a 30-year high in Japan, but the real concern lies in the central bank’s attitude toward the future path—whether it will continue to be hawkish and aggressively raise rates or adopt a more dovish stance and slow down.

The rate hike itself has been fully priced in; the question is about the extent. Nomura Securities issued a warning, stating that the current terminal rate is priced to rise to 1.0% by September 2026, which may be overly optimistic. Conversely, internal analyses from U.S. banks and the Bank of Japan indicate that the natural rate is rising, and the lower bound of the neutral rate is likely to be above 1.0%. This suggests that hawkish advocates believe there is much more room for rate increases than previously expected.

Arbitrage Traders Face a “Life or Death” Moment

Why does this rate hike trigger panic among global capital flows? The answer is simple: Japanese yen arbitrage trades are being unwound on a large scale.

Imagine that over the past decade, vast amounts of international capital borrowed at low-interest Japanese yen and invested in high-risk assets like U.S. stocks and cryptocurrencies. Once the Bank of Japan raises rates, the attractiveness of this trade diminishes sharply, and funds will inevitably flow back into Japan, putting pressure on U.S. stocks and Bitcoin. This scenario played out in July 2024—when the BOJ unexpectedly raised rates to 0.25%, the yen surged, U.S. stocks plummeted, and Bitcoin was heavily impacted.

However, this time may be different. Rate hike expectations are already fully priced in, and domestic fiscal stimulus policies in Japan continue to suppress the yen, so the impact is unlikely to be severe.

Where Will USD/JPY Go?

The outlook for the exchange rate is divided. U.S. banks lean toward a hawkish scenario, believing that “moderate rate hikes” will keep USD/JPY high, possibly pushing it toward 160. If hawkish policymakers take the lead, it could trigger yen short covering, pushing the rate down toward 150. However, U.S. banks consider the probability of an aggressive scenario to be lower.

Their target prices for 2026 are: Q1 160, Q2 158, Q3 156, Q4 155.

Nomura Securities is more optimistic, forecasting a gradual decline to 155→150→145→140 over the quarters in 2026. Their logic is that yen depreciation is fueling domestic political pressure, and narrowing interest rate differentials between Japan and the U.S. will reduce the attractiveness of arbitrage trades.

Conclusion

The December 19th decision will determine the market direction. If the central bank adopts a hawkish stance, high-risk assets will face pressure; if it leans dovish, the current situation may persist. Regardless, yen arbitrage traders are already calculating their next moves.