The market has been a little uneasy lately - expectations of a possible interest rate hike in Japan on December 19 are spreading like ripples.

You can see that the change has begun: the yen is strengthening, and bonds and stocks are falling. But it's not these that really make people nervous, but the behemoth hidden under the surface - the yen carry trade. How big is this thing? $3 to $4 trillion. Once Japan really raises interest rates, will it detonate a global financial storm?

This worry is not a blind worry. To understand why the market is so sensitive to yen interest rate hikes, we have to go back to the 80s of the last century.

# From "Buying America" to the Lost 30 Years

At that time, Japan was on fire, and the phrase "Japan wants to buy the United States" is no joke. The result? The Americans couldn't sit still and forced Japan to sign the Plaza Agreement. The yen soared in the short term, and exports stopped directly shutting down. The Bank of Japan panicked and cut interest rates frantically to stimulate the economy, resulting in housing prices flying to the sky, and finally had to raise interest rates and step on the brakes - "bang", the bubble exploded.

Since the 90s, the Japanese economy has fallen into the so-called "lost 30 years". Total GDP? It is stuck at about $5 trillion all year round, and it doesn't move at all.

There are two key reasons behind this.

**First**, after the real estate crash, the six major consortiums engaged in a "cross-shareholding" operation to digest bad debts internally. Sounds smart? In fact, the risk has never really been cleared, but everyone has carried it together.

**Second**, the economy has been sluggish for a long time and demand is sluggish. What will the Bank of Japan do? A large number of treasury bonds were issued, and interest rates were reduced to zero or even negative. Capital and industry? All went overseas.

# Yen carry trade: "Free lunch" in global financial markets

At this time, a huge market appeared - yen carry trades.

The logic is simple: borrow zero-interest yen, exchange it for high-interest dollars, or invest in high-growth markets (such as China more than a decade ago). What's the core? The yen has the lowest borrowing cost and has depreciated for a long time. You are betting on two things: the Bank of Japan will keep interest rates at zero, and the yen will continue to depreciate.

So how to borrow yen? The conventional operation is to use Japanese government bonds as collateral, revolving borrowing, and constantly increasing leverage. This is essentially a routine with the U.S. market using U.S. bonds as collateral and leverage to buy U.S. stocks.

But what are you most afraid of? Treasury bond prices fluctuated greatly.

Once the price of Treasury bonds falls past a certain critical point, you have to replenish your collateral. If you open high leverage, you can only deleverage - sell in the financial market and use cash to reduce financing leverage.

Assets with good liquidity and the easiest to liquidate are often the first to be sold.

And the most direct factor affecting the price of treasury bonds? The central bank adjusts interest rates.

# Why is the market so nervous about Japan's interest rate hike?

Now you get it.

Once Japan raises interest rates, government bond prices will fall and 10-year government bond yields will rise. This is likely to trigger passive deleveraging in the yen financing market and international carry trades.

Once deleveraging is initiated, a massive sell-off could erupt in global financial markets, triggering a financial storm that will sweep the world.

Is the impact great? Look at two numbers.

**First**, the scale of funds. The market size of Japanese government bonds is about $7.5 trillion, or 150% of GDP. Yen carry trade size? About $3 to $4 trillion. This volume is already very terrifying.

**Second**, to what level will Treasury yields fluctuate? This determines the scale of deleveraging of funds.

At present, the yield on Japanese 10-year government bonds has exceeded 1.9%, the highest level since July 2007. The market generally believes that the red line of the Bank of Japan is 2%. Now it is only 0.1 percentage points away from the red line.

If the price of Japan's 10-year government bond falls below 98, global financial markets may trigger a sell-off. The risk is real.

# How to go next?

At present, if the yen's long-term interest rate hike expectations do not continue to rise, the short-term deleveraging risk is still manageable. But if interest rate hike expectations continue to escalate? That's not sure.

This matter obviously involves a game within Japan. For example, Sanae Takaichi clearly opposed interest rate hikes before. So how to go in the end may depend on the attitude of the United States.

In any case, December 19 is worth keeping an eye on.