The End of Japan’s Negative Rates Will Be a Slow-Moving Tsunami

Japan’s stocks have reached levels that haven’t been seen for 34 years . The country is likely to hit another milestone soon: Its central bank could raise interest rates for the first time in 17 years as soon as Tuesday.

Higher, and positive, Japanese rates won’t reshape markets overnight. But the long-term effects could be profound, particularly if U.S. growth heads structurally lower for any reason, further narrowing the yield advantage of many U.S. assets. Japan is the single largest overseas holder of U.S. Treasurys, a major overseas lender, and an export heavyweight whose corporate earnings—and stocks—have been significantly supported by the ultra cheap Japanese yen. More Japanese capital staying at home could eventually impact the price of everything from U.S. mortgages to infrastructure finance in the developing world.

For much of the past two years, Japan has swum against global monetary tides, maintaining its ultra low interest-rate regime. But now, as most other major central banks are about to cut rates, the Bank of Japan is poised to break the trend again. Domestic media reported over the weekend that Japan’s central bank will end its negative interest rates, which have been in place since 2016, during its policy board meeting on Monday and Tuesday.

The decision would come after mounting evidence that the job market is on an increasingly strong footing , after years of stagnant wage growth. Unions secured an average salary increase of 5.28% , according to the first-round results of Japan’s annual spring wage negotiations, the Japanese Trade Union Confederation said last week. For the entire decade ending in 2022, the final annual increase never exceeded 2.4%.

Much likely won’t change in the short term. The Bank of Japan will probably pace its rate increases slowly: The past couple of years have, if anything, reaffirmed its reputation for moving slowly and deliberately. Moreover, while inflation is still high by Japanese standards—2.2% in January—it has already cooled from the peaks of last year.

Japanese bond yields have picked up, but they are still substantially lower than in the U.S. The rate differential between 10-year government bonds in the U.S. and Japan stands at 3.5 percentage points. That is significantly lower than the 4.2-percentage-point gap of a few months ago, but still way higher than the 1.5 percentage points of three years ago.

Even so, a narrowing rate gap—especially if the Fed cuts rates later this year, as seems likely—will support the Japanese yen . That could damp enthusiasm for rip-roaring Japanese stocks . They would become more expensive in dollar terms for foreign investors, who have been significant drivers of the rally. A stronger yen would also hit profits at some Japanese companies , especially big exporters.

Likewise, gradual interest-rate increases in Japan probably won’t change investment flows much in the short term. But it could be a different story down the road if the shift back to positive rates proves sustainable.

Japanese individuals and companies have been big investors abroad in search of higher yield for decades. The country’s foreign-portfolio investments stood at the equivalent of $4.2 trillion at the end of last year. A big chunk of that comes from Japanese pension funds and insurers, who would suddenly have more attractive options at home. Japanese investors, for example, hold around $1.1 trillion of Treasury bonds, making them the largest foreign owner.

Japanese investors have been scouring the globe for better returns for as long as most investors can remember. If that starts to change, the effects will be felt nearly everywhere—sooner or later.