Azernews.Az

Qabil Ashirov

Read more

The global economy has entered a new and potentially more complicated phase in monetary policy. The U.S. Federal Reserve raised its federal funds target range by 25 basis points to 3.75%-4.00%, and the Bank of Japan followed with another rate increase, lifting its benchmark rate from 1.00% to 1.25%. The BOJ's latest move takes its policy rate to the highest level in more than three decades.

Japan's rate decision is particularly important because the impact of its monetary policy extends far beyond the Japanese economy. While a Fed rate hike usually puts pressure on emerging-market currencies and financial conditions, changes in Japanese monetary policy can affect global capital flows through a different channel: the carry trade.

There is a long-standing joke in economics that there is the global economy and then there is the Japanese economy, because some of the rules that normally apply elsewhere have worked differently in Japan. For decades, Japan maintained exceptionally low interest rates while carrying a very high public debt burden. This created an unusually cheap funding environment for investors.

The carry trade developed around this environment. Investors could obtain funding in yen at relatively low costs and invest in assets offering higher returns elsewhere, including U.S. government securities, equities and emerging-market financial instruments. Turkiye, Mexico and other higher-yielding markets have been among the destinations for such strategies. The return can come from the interest-rate differential, while a stable or weaker yen can provide an additional advantage to investors whose funding is denominated in yen.

This second component is important. Over the past five years, the yen lost as much as roughly half of its value against the U.S. dollar at its weakest point. The dollar-yen exchange rate climbed from around the 110 area in the early part of the period to almost 164 yen per dollar in July 2026. In other words, investors who had borrowed or otherwise funded positions in yen and invested in dollar-denominated assets could benefit not only from the interest-rate differential, but also from the yen's prolonged depreciation. Reuters reported that the yen reached 163.99 per dollar in July before strengthening to 152.89 by early September.

This is precisely why the Bank of Japan's policy normalization matters to global markets. A 1.25% Japanese policy rate is still considerably below rates in the United States and many emerging markets. Therefore, the latest increase by itself does not mean that the carry trade is suddenly finished. The interest-rate differential remains substantial.

The bigger issue is what happens next.

If the BOJ continues raising rates while the yen strengthens, the economics of the carry trade can change significantly. Investors who borrowed cheaply in yen would face higher funding costs. At the same time, a stronger yen could reduce or eliminate the currency gains that previously supported the strategy. If leveraged investors begin closing positions simultaneously, they may have to sell assets in other markets in order to repay yen funding.

That does not automatically mean a global financial crisis. However, a large-scale unwinding of carry trades could create additional volatility, put pressure on asset prices and reduce liquidity in some markets. The International Monetary Fund has also noted that changes in Japanese bond-market conditions can spill over into overseas markets, with particularly strong effects in markets where Japanese investors have a larger presence.

The global inflation environment makes the situation even more complicated. The unresolved Russia-Ukraine war and tensions in the Middle East have increased the risks surrounding energy markets. Disruptions around the Strait of Hormuz, through which a major share of global oil flows, can quickly affect crude prices. At the same time, instability around Yemen and the Red Sea can increase shipping and insurance costs and put additional pressure on global logistics.

Higher energy and transportation costs can feed into inflation. If inflation remains persistent, central banks may have less room to cut interest rates and could be forced to keep monetary policy restrictive for longer. This creates an unusual combination: Japan is moving away from its ultra-loose monetary policy at the same time that other central banks are also dealing with inflationary pressures.

For global investors, therefore, the important question is not whether Japan's 1.25% rate is high. It clearly is not when compared with many other economies. The question is whether the combination of further BOJ tightening, yen appreciation and narrowing interest-rate differentials will be strong enough to change global investment flows.

For Azerbaijan, however, this process could create not only risks but also an opportunity. Azerbaijan is a significant energy exporter and has a sovereign investment institution, the State Oil Fund of Azerbaijan (SOFAZ), whose mandate includes managing foreign-currency assets and generating investment returns. SOFAZ's 2026 investment policy provides for substantial allocations to fixed-income assets, equities and other international investments. Therefore, if a future carry-trade unwind forces some investors, including Japanese investors, to reduce positions in U.S. or high-yield emerging-market assets, prices of selected securities could come under pressure while their yields rise. A long-term sovereign investor with sufficient liquidity could potentially enter such markets at more attractive valuations and lock in higher future returns. This would not mean simply buying whatever Japanese investors sell, or assuming that every high-yield asset is attractive. The opportunity would depend on credit quality, currency risk, liquidity, maturity and market conditions. But in a global environment where forced selling creates temporary price dislocations, Azerbaijan's energy revenues and sovereign investment capacity could potentially allow it to act as a long-term buyer rather than a forced seller.