Bank of Japan's December decision imminent: Hawkish or dovish? The market's two camps are betting very differently

The key moment for the Bank of Japan’s rate hike is approaching. The December 19th interest rate decision will serve as a weather vane for the upcoming global capital flows, with profound implications especially for the USD/JPY exchange rate and the cryptocurrency market.

Rate hike expectations are now settled, focus shifts to “hawkishness” judgment

The market generally expects the Bank of Japan to raise rates to 0.75%, hitting a 30-year high. However, this rate hike is different from previous ones—the increase itself has already been fully priced in, and investors are now paying close attention to Governor Ueda Kazuo’s attitude towards future rate hikes.

According to analyses from most institutions, the BOJ may revise upward its neutral interest rate estimate and signal more rate hikes. Currently, market pricing indicates that rates could rise to 1.0% by September 2026. Nomura Securities, however, believes that such market expectations tend to be overly “dovish”—in other words, the market’s anticipation of the pace of rate hikes may be too aggressive.

The “butterfly effect” triggered by rate hikes

The most direct impact of Japan’s rate hike is the unwinding of arbitrage trades. When Japanese interest rates rise, investors holding USD/JPY arbitrage positions face downward pressure, leading to a large outflow of funds from high-risk assets (U.S. stocks, cryptocurrencies) back to the Japanese market.

The history of July 2024 offers us a lesson. When the BOJ unexpectedly raised rates to 0.25%, it triggered a sharp reversal in carry trades, causing the yen to surge and leading to declines in U.S. stocks and Bitcoin.

But this time, the impact should be much milder. On one hand, the rate hike expectations have been fully digested by the market; on the other hand, the Japanese government is implementing large-scale fiscal stimulus, which will offset the yen’s appreciation pressure.

Two scenarios for USD/JPY

According to analysis from U.S. banks, the future trend of the yen after the rate hike will depend on whether the central bank adopts a “dovish” or “hawkish” stance.

If it is a dovish rate hike (dovish tendency): USD/JPY will remain high and may push toward 160 early next year. U.S. banks’ forecasts for 2026 are: Q1 160, Q2 158, Q3 156, Q4 155.

If it is a hawkish rate hike: Yen short covering will be triggered, and USD/JPY could fall to around 150. However, most industry insiders believe this scenario has a lower probability.

Nomura Securities is more optimistic. The firm points out that the continued depreciation of the yen is causing political pressure within Japan, and as the U.S.-Japan interest rate differential narrows, the attractiveness of yen arbitrage trades is diminishing. Therefore, they forecast a quarterly decline in USD/JPY to target levels: Q1 155, Q2 150, Q3 145, Q4 140.

How should investors respond?

Regardless of which path the central bank chooses, the key is to position in advance. Rate hike expectations are already reflected in market prices, and the real opportunities often lie in marginal changes in the central bank’s stance. For cryptocurrency investors, paying attention to the direction of arbitrage trades is more important than simply focusing on the magnitude of rate hikes.