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20 Dec 2025

Japan’s Historic Rate Hike and What It Means Globally

On December 19, 2025, the Bank of Japan (BoJ) raised its benchmark short-term interest rate by 25 basis points to 0.75%, taking it to the highest level in three decades a move widely expected but significant given Japan’s long history of ultra-low policy rates.

The decision marks a continuation of the BoJ’s gradual shift away from the near-zero and negative interest rate era that dominated Japan’s monetary policy for decades. Since the early 1990s, Japan battled slow growth and deflation, prompting policymakers to maintain exceptionally loose conditions to spur demand. Only in recent years as inflation settled consistently above the BoJ’s 2% target the bank has begun a careful unwind of this policy.

Figure 1: Japan interest rate

Why Japan Is Raising Rates Now

For years, the Japanese economy struggled with weak demand, stagnant wages, and deflation a prolonged low-inflation or negative-inflation environment. To combat this, the BoJ adopted unconventional policies such as negative rates and massive asset purchases, keeping borrowing costs low to stimulate spending.

However, recent data show inflation around 3%, slightly above target, coupled with a tight labour market and rising wages conditions that have bolstered the argument for withdrawing some monetary support.

Figure 2: Japan inflation

BoJ Governor Kazuo Ueda emphasized that while the current rate is still below the estimated neutral range, the bank is prepared to raise rates further if inflationary trends persist and economic fundamentals support it.

Ripple Effects on the U.S. Economy

1. Impact on Global Funding and Carry Trades

For years, investors engaged in what’s known as the yen carry trade: borrowing cheaply in yen (because of Japan’s low rates) and investing in higher-yielding assets elsewhere especially in the United States. Rising Japanese rates narrow that yield gap, making this strategy less attractive.

As a result:

-> Demand for U.S. Treasuries could drop if Japanese investors find better yields at home.

-> This could push U.S. yields higher, increasing borrowing costs for households and businesses. Historical analysis suggests Japanese investors have been among the largest holders of U.S. Treasuries, so any shift matters for global interest rates.

2. Currency Volatility and Risk Sentiment

A stronger Japanese yen is a possible outcome if markets begin anticipating a more sustained policy shift, this may influence USD/JPY exchange rates and broader forex markets. When the yen strengthens, some investors reduce dollar-denominated holdings, which can drive short-term market volatility.

While the direct economic linkages between Japan and the U.S. are smaller than the U.S.–China dynamic, financial market linkages (bonds, equities, forex) are strong. Asset managers and banks around the world calibrate portfolios based on relative interest rates, and a shift in Japan forces adjustments across global portfolios.

What It Means for India

India, as a major emerging market, is intricately tied to global capital flows and investor sentiment. BoJ’s moves, though geographically distant still echo into Indian markets.

1. Equity Market Sentiment

Indian markets responded positively on the day of the BoJ hike, suggesting investors had priced in the move and looked ahead to commentary on future policy direction.

However, the risk is in further tightening: if markets anticipate sustained hikes, investors might unwind riskier positions globally, including in emerging equities. Foreign Institutional Investors (FIIs) often move capital on relative return expectations across geographies.

2. Currency Impact

If the yen strengthens, it indirectly affects the USD/INR exchange rate since capital flights during risk-off periods flow toward safe havens like the U.S. dollar. A stronger dollar often correlates with downward pressure on INR, affecting imports and inflation dynamics in India.

3. Bond Yields and Interest Rates

A shift in global bond markets, influenced partly by changes in Japanese Treasury buying behaviour, could affect Indian bond yields as global investors rebalance portfolios. Emerging market debt becomes risk-priced against global yields higher global yields could push Indian yields up as well.

The Broader Takeaway

The BoJ’s rate hike is more than a domestic policy tweak it’s a signal that the world’s third-largest economy is altering its monetary stance after decades of ultra-loose policy. While Japan’s economy remains structurally challenged, the shift influences global capital flows, risk sentiment, and relative returns across major markets.

For the U.S., think of this as a recalibration of global funding dynamics, with potential implications for Treasury markets and cross-border investment strategies.

For India, the effects are subtler but real from equity market responses to currency and bond pressures all filtered through the prism of global investor behaviour.

In a globally interconnected financial system, no central bank operates in isolation. Japan’s ascent from the era of negative rates enhances market complexity, underscoring the need for investors and policymakers to watch global monetary trends closely.

India’s Bear Market: What Broke, What’s Holding Up, and What Comes Next

Indian equities over the last year and a half have been quietly challenging. Many investors are facing the same uncomfortable situation: Headline indices are close to all-time highs, yet portfolios remain in the red. This disconnect has led to confusion, frustration, and a fair bit of denial. After all, how can markets be “fine” if most stocks and most investors are not?

The Real Starting Point: Slowing Nominal Growth

Every market cycle eventually comes down to growth not just real GDP growth, but nominal growth, which combines volumes and pricing. During the post-covid boom, nominal GDP surged into the mid-to-high teens. That period created the perfect environment for earnings upgrades, margin expansion, and valuation rerating across sectors.

That tailwind has now faded. Nominal growth has slowed meaningfully, settling into a single-digit to low double-digit range. When pricing power weakens and inflation cools, companies find it harder to grow revenues meaningfully. Volumes may still rise, but without pricing, earnings momentum inevitably slows.

This is where the current trouble really began, not with stocks but at macro-economic level.

Figure 3: India’s Nominal GDP Growth Trend

Policy Tightening Did Its Job

The slowdown didn’t happen overnight. Monetary tightening that began in late 2023 was designed to control inflation and excesses in credit growth, particularly in unsecured and NBFC lending. Interest rates rose, liquidity tightened, and lending standards became stricter.

The catch with policy tightening is timing. Its impact typically shows up with a lag of 12–18 months. That lag is exactly what investors are experiencing today. Credit growth slowed, consumption weakened, and corporate confidence took a hit. While policy is now easing again through rate cuts and tax relief, the recovery in demand will take time to filter through the economy.

Markets, as always, reacted first.

Foreign Flows, Currency Pressure, and Liquidity Drain

Foreign investors sensed this shift early. High valuations, slowing growth, and a weakening currency made Indian equities less attractive on a risk-adjusted basis. As foreign selling picked up, currency depreciation accelerated, forcing even more selling to protect dollar returns.

This dried up liquidity especially in smaller stocks. When liquidity dries up, price discovery becomes brutal. Stocks fall not because businesses are broken overnight, but because there are simply no incremental buyers left.

Market Breadth Tells the Real Story

Perhaps the strongest evidence of a bear market lies in market breadth. While indices appear resilient, participation has collapsed. A small set of large-cap stocks is holding up benchmarks, while the majority of the market trades well below recent highs.

Mid-cap and small-cap stocks have suffered deep drawdowns, often ranging from 25% to 35% on a median basis. For most investors who entered the market over the last five years, this feels nothing like a sideways phase.

Figure 4: Weak Market Breath

Where the Damage Has Been the Worst

The sharpest corrections have occurred in sectors that were once market favourites: government-dependent businesses, EPC, renewables, power equipment, defence ancillaries, water infrastructure, and EMS players. These segments benefited enormously from capex optimism and abundant liquidity.

Now, delayed payments, stretched working capital cycles, and cash-flow concerns have taken centre stage. Markets are no longer rewarding order books alone. Cash generation, balance sheet strength, and execution discipline matter far more in this environment.

What’s Holding Up and Why

Bear markets are selective, not universal. Even now, certain pockets are showing relative resilience:

-> Large-cap banks with strong deposit franchises

-> Consumer staples with steady demand visibility

-> Long-duration bonds, benefiting from low inflation and slowing growth

Leadership has shifted from momentum to stability. This is typical of late-cycle and risk-off phases.

How Long Could This Last?

Bear markets usually end when growth expectations bottom and start improving again. While policy support is now visible and financial conditions are easing, demand recovery is still tentative. Consumption needs to revive more decisively, private capex must regain confidence, and external trade conditions need to stabilise.

Realistically, this suggests the current phase could linger for another couple of months, with early signs of recovery emerging toward the H2 of FY26.

The Bigger Picture

This bear market isn’t about panic, it’s about digestion. Excess liquidity, leverage, and optimism from the previous cycle are being unwound. The next bull market will look very different from the last one. New leaders will emerge, old favourites will need time, and valuation discipline will matter again.

For investors, this phase isn’t about aggressive bets. It’s about patience, selectivity, and survival. Markets may feel unfriendly today, but they are quietly laying the groundwork for the next cycle as they always do.

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