The Market Reaction to Japanese Interest Rate Increases
This study investigates whether the global market sell-off following the Bank of Japan’s exit from negative interest rates in 2024 was caused by a panic-driven cash squeeze or a straightforward mathematical repricing of future investment returns
The global market wobble following Japan’s 2024 rate hikes was driven by investors recalculating expected returns, not by a structural liquidity crunch in currency borrowing.
Key Points
Math, Not Panic: Investors unwound yen "carry trades" because higher Japanese interest rates narrowed the profit margin on borrowing yen to invest abroad, not because lenders ran out of money.
Global Risk, Not Yen Contagion: The dramatic financial market wobble in August 2024 was driven by broad global risk concerns rather than a localized crisis in Japanese currency markets.
Communication Matters Most: Central bank messaging about the future economic outlook influenced carry trade returns far more than the size of the immediate interest rate change itself.
For much of the past decade, financial markets relied on a popular investment strategy: borrow Japanese yen at near-zero (or negative) interest rates and invest the proceeds in higher-yielding assets abroad, such as Mexican pesos or American tech stocks. This strategy, known as a currency "carry trade," yielded steady profits as long as Japanese rates remained rock-bottom.
When the Bank of Japan ended its negative interest rate policy in 2024 and subsequently raised rates in July, the yen strengthened sharply. Within days, global stock markets slid, culminating on August 5, 2024, in the Nikkei 225's worst single-day drop since 1987. This sudden market turmoil raised a crucial question for policymakers and investors: Was this shock caused by a dangerous breakdown in borrowing networks (a funding liquidity crisis), or was it simply investors adjusting to lower profit margins?
Research
Economist Seungho Lee examined daily financial data surrounding the Bank of Japan’s key policy announcements in 2024. To isolate the root cause, he tracked how currency returns, equities, volatility metrics, and digital assets adjusted over short and long horizons.
To ensure the market swings were truly caused by Japanese borrowing conditions, Lee implemented clever "falsification tests"—comparing the yen network against hypothetical trades funded in Swiss francs, as well as testing a market network that removed carry trades entirely.
Findings
The study's findings point clearly toward a repricing of returns rather than a funding crisis.
In a true liquidity crunch, nervous lenders pull cash from the market, causing future expected returns to rise sharply to tempt remaining investors back into the trade. Instead, statistical projections showed that carry trade returns remained negative for up to twenty trading days after the rate hike surprise. This sustained drop demonstrates that investors lowered their long-term expectations for carry trade profits due to a shrinking interest rate gap.
Crucially, the study proved that the accompanying cross-asset market volatility was not a uniquely "yen" phenomenon. When testing a Swiss franc-funded portfolio across the same period, global assets like the S&P 500 and Bitcoin exhibited almost identical volatility.
Removing carry trades from the statistical model entirely still reproduced the wider market turbulence. This reveals that the August 2024 market shakeup was driven by general global risk shifts—including a soft U.S. employment report released around the same time—rather than a localized crisis in Japanese credit.
Furthermore, Lee decomposed central bank announcements into pure interest rate changes and "information shocks" (news revealing the central bank's economic outlook). The analysis showed that carry returns responded almost exclusively to information shocks, emphasizing that investors care far more about the future direction of monetary policy than the immediate quarter-point change.
Limitations
Because the Bank of Japan made only two major policy moves during this period, much of the statistical precision rests heavily on the single announcement made on July 31, 2024. Additionally, using daily close data rather than minute-by-minute intraday prices means some external news may blur the exact window of response.
Why It Matters
If the 2024 sell-off had been caused by structural funding stress, central bankers might have needed to step in with emergency market intervention. Demonstrating that the turbulence was actually a standard repricing event offers reassurance: markets were adjusting efficiently to changing yield math. For policymakers, the research underscores that clear communication regarding future rate paths remains a potent tool for avoiding unnecessary financial volatility.
Learn More
Paper Title: Repricing or Funding Stress? The Yen Carry Trade and Global Spillovers around the Exit from Negative Interest Rates
Author: Seungho Lee
Journal: Working Paper (University of Aberdeen Business School)
Publication Year: 2026
URL: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=7524754
Econ Today Explains
Economic Concept: The Carry Trade
A carry trade is an investment strategy in which an investor borrows money in a country with very low interest rates (the "funding currency," such as the Japanese yen) and uses it to purchase higher-yielding assets in another country (the "target currency," such as the Mexican peso or U.S. dollar).
The investor earns a profit on the difference between the two interest rates, known as the interest rate differential. While lucrative during calm periods, carry trades carry hidden risks. If the borrowing currency appreciates rapidly or global volatility spikes, investors can be forced to quickly sell off their target assets to pay back their loans, turning a steady profit stream into a swift loss.
This article was written by AI but reviewed by a real human.
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