Japan's unexpectedly robust economy fuels rate hike expectations, potentially triggering a global unwind of carry trades in September.

Last weekend, a survey released by S&P Global showed that Japan’s services Purchasing Managers’ Index (PMI), compiled by S&P Global, rose from 51.2% in July to 52.5% in August. This indicates that Japan’s services sector expanded in August at its fastest pace in five months, driven by strong customer demand. Business activity and new orders have now grown for 26 consecutive months—and at a faster pace than in July. Notably, new export orders in the services sector contracted for the fifth month in a row, at the steepest rate since November 2020; domestic demand, however, continued to strengthen. Employment in the services PMI hit its slowest pace of job creation in one year. Though the growth was modest, it marked the 12th consecutive month of expansion—still an impressive performance. Input price inflation in the services sector eased to a four-month low, yet remained among the fastest over the past three-and-a-half years. Meanwhile, output price inflation accelerated to the second-highest level on record, reflecting Japanese firms’ ability—amid strong demand—to pass rising input costs onto downstream customers. Amid this sustained services expansion, Japan’s manufacturing sector also displayed continued resilience: its August manufacturing PMI was revised upward to 54.9%, slightly below the preliminary estimate of 55.1% but still above July’s 54.5%, marking the eighth consecutive month of expansion. The survey further revealed that export orders in manufacturing surged at the fastest pace since early 2018, propelled by robust demand for chips and AI-related products. Raw material procurement rose steadily alongside increased output, yet supplier delivery times lengthened markedly—suggesting capacity constraints are emerging in certain sectors. The broader composite PMI—which covers both manufacturing and services—rose to 53.5% in August, up 0.8 percentage points from 52.7% in July, representing the strongest monthly gain since February. Annabel Fiedes, Deputy Chief Economist at S&P Global Market Intelligence, commented: “Overall, Japan’s manufacturing sector is poised to remain strong, especially against the backdrop of surging demand linked to artificial intelligence. Meanwhile, the latest PMI data shows that Japan’s services sector gained further momentum in August, with business confidence improving relative to July.” Fiedes added that persistent cost pressures suggest “official inflation may rise further in the coming months—and as inflation strengthens, it increases the Bank of Japan’s rationale for another interest-rate hike.” II. Sustained and vigorous economic expansion has heightened market expectations of a BOJ rate hike in September. Following the release of the latest economic data, expectations for a Bank of Japan (BOJ) rate hike surged sharply. On September 2, BOJ Governor Kazuo Ueda stated that, given the yen’s depreciation, rising oil prices, and intensifying inflationary pressures on Japan’s economy, policymakers would closely monitor the possibility of a rate hike at their September meeting. The BOJ’s next monetary policy meeting is scheduled for September 17–18. Markets are increasingly betting that policymakers may raise the current policy rate of 1%. Ueda did not commit to any increase. However, he explicitly stated that the central bank would assess whether inflation risks are intensifying—and whether economic conditions continue to align with the BOJ’s forecasts. His remarks immediately triggered closer scrutiny of the yen, Japanese government bonds, and global interest-rate markets.

The yen surges violently! Besent is calling the shots—anyone wanting to bet against him, step right up!

To rescue U.S. Treasuries, Besent had to rescue the yen. Since September 2, the yen’s exchange rate trend reversed sharply, with the currency rallying strongly—USD/JPY plummeted from 160, briefly breaking below 153! Why has the yen’s appreciation been so forceful? On September 8, Besent publicly declared that, in intervening in the yen’s exchange rate, he possessed full insight into Japanese policymakers’ next moves: “I am the house now… If you want to bet against me, go ahead!” Neither the U.S. nor Japanese governments intervened in foreign exchange markets in September—so how did Besent pull this off? Psychological warfare: flooding the market with signals to reverse expectations The G20 meeting held from August 30 to September 1 became the pivotal turning point. Besent loudly proclaimed that Japan’s ‘Abenomics’ had run its course—partially restoring market confidence in Japan’s fiscal sustainability. He also formally announced that BOJ Governor Kazuo Ueda, backed by Prime Minister Shigeru Ishiba, would “take appropriate measures” on monetary policy—meaning the BOJ would definitely hike rates in September! Besent delivered a decisive blow to the highly leveraged yen foreign-exchange market structure by releasing such unambiguous signals. Immediately afterward, a cascade of confirmatory signals followed: On August 31, the Government Pension Investment Fund (GPIF)—the world’s largest pension fund, managing $2 trillion in assets—unexpectedly published a meeting agenda revealing it had convened an emergency management committee meeting on August 21. Markets speculated GPIF might soon increase purchases of Japanese assets. On September 1, Norges Bank Investment Management (NBIM)—managing $2.2 trillion—announced it would rebalance its portfolio, purchasing approximately $17 billion worth of Japanese government bonds. On September 2, BOJ Governor Kazuo Ueda stated that the central bank would consider upside risks to inflation when setting monetary policy—pushing market-implied odds of a September rate hike close to 100%. Hawkish board member Soichiro Takada poured fuel on the fire, suggesting the hike could exceed 25 basis points—and possibly be followed by further hikes. Three waves of action: driving the yen’s violent appreciation! First wave: unwinding of carry trades and leveraged short positions The yen has long served as the world’s most important funding currency: hedge funds borrow yen at ultra-low interest rates, convert them into dollars, and invest in U.S. Treasuries and other dollar-denominated assets—profiting from the U.S.–Japan interest-rate differential, i.e., the carry trade. This is a highly leveraged strategy—designed to earn stable spreads—but extremely vulnerable to two simultaneous developments: yen appreciation and rising yen interest rates. When both occur, losses mount on both fronts. Once the market fully priced in a September rate hike, traders began anticipating a narrowing of the U.S.–Japan yield spread. Sensitive hedge funds acted first: selling dollar-denominated assets, buying back yen, and repaying yen loans—initiating large-scale unwinds. Nomura Securities exclaimed, “We are witnessing the unwinding of yen carry trades…” At the start of September, numerous hedge funds and Japanese retail investors still held massive short-yen positions—betting the yen would keep depreciating. But once the probability of a rate hike approached 100%, savvy short-sellers fled immediately!

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