Japan raises rates, unwinds carry trade: is the 'dancing bear' coming?

Japan tightens the yoke: is the 'dancing bear' coming to markets?

What is this 'dancing bear' that some have been announcing for weeks with apocalyptic airs? The expression, which mixes the traditional 'bear' of bear markets with dance, has skyrocketed in investment jargon after a mysterious tweet from the account @yutokanzakireal, which claims to leak information from inside the Bank of Japan (BoJ). The message, in Japanese, came with apologies to Western citizens and a promise of 'measures that will affect billions of people'. The market interpreted it as a warning: Japan is going to stop financing global excess. And the data gives it some credence.

The yen carry trade is in the crosshairs

To understand the scare, we need to talk about the yen carry trade. For years, the BoJ kept interest rates negative, allowing ultra-cheap loans in Japan to buy US or European government bonds, earning the differential. A flow of money that fattened balance sheets and fueled the purchase of risk assets worldwide. Estimates of the total volume of these leveraged positions range between $1 and $4 trillion, although much of the pie is not officially declared: it moves in the shadows of derivatives and hedge funds.

When the BoJ started raising rates - from negative territory to the current 0.25%, and with promises of further hikes - the whole scheme began to wobble. Those who borrowed in yen to buy foreign assets face a dilemma: repay loans with a more expensive yen or sell assets to cover themselves. And when many sell at once, the domino effect is devastating: falling government bonds, rising global rates, and turbulence in emerging markets.

It's not the first time, but the magnitude is concerning

The script is not new. In the summer of 2024, a similar mini-storm already shook markets when the BoJ unexpectedly raised rates. Western central banks came to the rescue with emergency cuts and currency swaps. But that was a summer storm. What is brewing now is a structural trend change: Japan, the lender of half the world for three decades, wants to stop being one. The Asian country no longer has a deflationary economy; inflation has returned and its aging population pushes toward gradual normalization. Each rate hike makes global credit more expensive and reduces liquidity.

The numbers are not pretty, but not catastrophic either, at least on paper. The total exposure of the financial system to the yen carry trade, although in the millions, is manageable if the process is orderly. The problem is estimulante ilegal: if the BoJ surprises with a sudden move, panic can trigger massive selling. Hence the preventive apologies that some interpret as a warning: 'we are forced to screw up the works, we're sorry'. Japanese politeness, even in collapse, is exemplary.

What if it's all a bluff?

Not everyone believes it. Some argue that the @yutokanzakireal account is a simple cryptocurrency agitator, who has been spreading hoaxes for years about XRP adoption or supposed secret agreements with the United States. Its track record is riddled with unfulfilled announcements and half-truths. That it has now become a prophet of the 'dancing bear' says more about investors' anxiety than its credibility. Japan, skeptics argue, will not allow a collapse that drags down its own banks and pension funds. The BoJ has tools to intervene and will do so if necessary: the goal is gradual normalization, not financial harakiri.

Moreover, Western dependence on the yen as a funding currency has limits. Since the BoJ exited negative rates in the spring of 2024, much of the carry trade has already been unwound or relocated to other destinations (such as the Swiss franc or the dollar). What remains is less liquid and more volatile, but not enough to cause a systemic crash. The real threat, perhaps, is not Japanese abruptness, but the accumulation of global debt that any rate hike - from wherever - exposes.

The million-dollar question: what to do with money

For the retail investor, uncertainty is a burden. Buying yen now makes little sense because the carry trade is already unwinding and the BoJ will raise rates drop by drop: if you enter too early, the exchange rate will dance on you in 48 hours. Better to wait for the 'dancing bear' to truly land and then, if the yen spikes 10%, do fiscal harakiri by buying at the peak. The recommendation circulating among analysts is harsh: don't buy anything you can't fit in a backpack and run. Financial assets will suffer volatility, government bonds lose appeal with rising rates, and stock markets, especially the Nikkei and emerging indices, will take the worst hit. The Ibex, for a change, will dance to the tune played from outside.

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All in all, Japan's warning is one more symptom that the era of free money is ending forever. That a country with the highest public debt in the world has to raise rates to contain its inflation is an irony of history. Meanwhile, the dancing bear keeps rehearsing its steps. Who knows if it will end up dancing on the rubble of a system that lived on borrowed money for years.