How Shifting Policies in Japan and China May Affect US Interest Rates

Major policy shifts in Asia could have ripple effects on US interest rates over the next few years.

Here’s a look at how changes in Japan and China may become a headwind for interest rates in America.

Japan Ends Yield Curve Control

The central bank has ended its decade-long yield curve control policy in Japan.

This involved manipulating interest rates to keep borrowing costs ultra-low.

The goal was to stimulate Japan’s stagnant economy, where growth has been meager for decades.

Under yield curve control, the Bank of Japan artificially suppressed short-term rates to zero. And they put a ceiling on 10-year rates through massive bond-buying programs.

Economists estimate this policy drove trillions of dollars of Japanese investments into the US and other nations in search of higher returns. As yield curve control winds down, some of this global capital may flow back into Japan.

What This Means for US Interest Rates

As Japanese investment money comes home, it could lead to Japanese entities selling their holdings of US assets. This includes stocks but especially US Treasury bonds.

Less demand for Treasuries typically causes bond yields to rise. And since Treasury yields influence other US interest rates, borrowing costs for things like mortgages could be pressured.

The repatriation of Japanese investments may put moderate upward pressure on US interest rates in the coming years. The exact magnitude is uncertain, but it’s poised to become a headwind at a time when the US Federal Reserve is already raising rates to fight inflation.

China’s Slowdown is Also a Factor

Japan isn’t the only Asian economy causing ripples. China faces a slowdown driven by a stagnant property sector and construction slump.

Deflation now looms as a significant risk in China – a scenario similar to Japan in the 1990s after its real estate bubble burst.

To stabilize its currency against outflows, China may need to sell some of its vast US Treasury holdings. Less demand from China would add further upward pressure on US yields.

Could Asia’s Woes Ease US Inflation?

On the flip side, weaker Asian growth could somewhat dampen inflation in the US. With less demand for US exports, prices of imported consumer goods may not rise as quickly.

This could allow the Fed to raise US rates less aggressively than if Asia was booming. But most economists think the countervailing force of fewer Asian imports is minor compared to the impact of higher yields caused by overseas investment flows returning home.

Key Takeaway

While the Fed will remain driven by US growth and inflation, policies and challenges in Asia are poised to be a moderate headwind for American interest rates.

Japan ending yield curve control and China’s slowdown will likely add upward pressure on US borrowing costs.

Investors and consumers should brace for Asian developments to contribute incrementally to rising interest rates in the US. But the timing and magnitude of impacts remains murky.

However, domestic inflation, the relationship between GDI (gross domestic income) and GDP (gross domestic product), and employment data will likely remain the primary influence of the Fed’s Interest Rate policies (Fed Funds Rate) moves, up or down.