In mid-December, the Bank of Japan made a seemingly tough decision: to raise the Benchmark Interest Rate by 25 basis points, escalating it to 0.75%, the highest level since 1995. Normally, this should trigger a surge in the value of the yen. What happened instead? The completely opposite scenario unfolded.

The yen not only failed to rebound but also began to depreciate rapidly. The market data on Monday was shocking: the USD/JPY temporarily soared to 157.67, the EUR/JPY surged to 184.90, and the CHF/JPY approached 198.08. These are all historical lows. Japanese authorities could not stand by any longer and began to speak up frequently. Deputy Finance Minister Atsushi Mitamura warned that the exchange rate fluctuations were too "one-sided and severe," and Finance Minister Shunichi Suzuki also made a statement, saying Tokyo would take action against those "excessively speculative fluctuations." The market is now waiting to see that once the USD/JPY hits the critical level of 160, the Japanese government will likely intervene again—just as they did in the summer of 2024, when they sold off about 100 billion USD in one go to stabilize the market.

The interest rate hike has instead contributed to the collapse of the yen. What exactly is going on? Behind this lies three puzzling market paradoxes.

**First of all, the market has long digested the interest rate hike.** The night before the announcement, the overnight index swap market had already priced in the probability of this rate hike at nearly 100%. This is a common pattern - the market runs ahead, and when the actual news lands, it turns into a "buy the expectation, sell the fact" reverse operation. Those who bought yen in advance rushed to take profits, and new buying couldn't keep up at all.

**Secondly, Japan's real interest rate is actually still negative.** Although the nominal interest rate has risen to 0.75%, Japan's inflation rate is as high as 2.9%, which means the real interest rate is about -2.15%. Looking at the United States, the nominal interest rate is 4.14%, inflation is 2.7%, and the real interest rate is +1.44%. The actual interest rate differential between the U.S. and Japan exceeds 3.5 basis points—how significant is this price difference? It's enough to sustain an entire arbitrage trading chain. Borrowing cheap yen, then buying high-yield U.S. dollar assets, waiting for the interest rate differential to fill your pockets. Under such temptation, the yen continues to be sold off; who would still be willing to foolishly hold onto yen?

**The third issue lies in the dovish stance of the Bank of Japan.** Although there was a rate hike this time, the subsequent statements from the governor became crucial. The signals released by the Bank of Japan are not strong, and the market does not have high expectations for further tightening of policies. In contrast, the Federal Reserve's firm position and the potential for prolonged high interest rates make the US dollar appear more attractive.

This currency crisis reflects a deep dilemma: Japan wants to stabilize the yen by raising interest rates, but finds itself caught in a double bind of liquidity and interest rate spreads. Nominally taking action, it is actually completely countered by the market's arbitrage logic.