Why investors need to watch Japan as a key source of market risk in 2025

The US stock market’s stability could hinge on developments in Japan’s bond market in 2025, BCA Research said in a recent research report.

The firm said Japan is the main driver of global liquidity, meaning the biggest risk to US tech valuations does not come from a rise in US real bond yields, but from a rise in Japan’s real bond yield.

Those risks have yet to be factored into market price, the firm added.

“The most important thing in 2025 that people are not talking about is Japan,” the firm’s chief strategist Dhaval Joshi wrote in a note last week.

Joshi pointed to Japan’s increasingly important role as a provider of global liquidity. He said the Nasdaq’s boom and bust cycle moved in perfect lockstep with that of the US real bond yield in 2019 through 2022 before detaching.

It then tracked Japanese yields, the world’s last remaining negative real bond yield and the two have since moved in almost perfect lockstep.

“This means that the biggest risk to US tech valuations does not come from a rise in the US real bond yield. The biggest risk comes from a rise in the Japanese real bond yield,” Joshi said.

Risks are mounting, too, since Japan’s zero-interest rate policy appears unsustainable and set to potentially move higher next year, alongside expectations for higher interest rates in the US as well.

Investors already got a glimpse of this development earlier this year, when the so-called carry trade came apart and drove a global sell-off in August. The carry trade refers to investors borrowing at near-zero interest and deploying that cash into higher-yielding assets around the world, such as US stocks and bonds.

After the Bank of Japan unexpectedly raised interest rates 15 basis points amid the prospect of the Federal Reserve cutting rates, the yen strengthened. That sparked a wave of margin calls, leading to speculators unwinding their positions and selling stocks.

“Do not underestimate this risk. Today’s edifice of US tech stock valuations is founded on Japan’s negative real bond yield. Yet with Japanese long-term inflation expectations moving closer to the 2 percent target, the Bank of Japan’s zero-interest rate policy (ZIRP) – and Japan’s negative real bond yields – will become unsustainable in 2025,” Joshi said.

In addition to Japan’s bond market, analysts have pointed to risks in 2025 including passive investing, investor uncertainty, and slowing earnings growth.

In a separate note, BCA Research wrote that it sees a bear market coming for stocks in the first half of 2025 amid slowing consumer spending, a weaker labor market, and lofty valuations.