Japan got so spooked by Monday's market meltdown that it's now playing cool on more interest-rate hikes

Some analysts blamed the August 5 market meltdown on recent Japan's rate hike that tipped markets over the edge, amid existing macro concerns.

• Stocks are rising after Monday's meltdown as Japan assured it will not hike rates if markets are unstable.
• Some analysts say BOJ's recent rate hike triggered Monday's sell-off as traders unwind yen carry trades.
• The uncertainty in carry trades could complicate Fed interest rate decisions. Rapid cuts could unravel more carry trades.

Japan's central bank has capitulated to the markets.

Just last week, the Bank of Japan hiked interest rates and struck a hawkish stance that signaled more increases ahead following years of ultra-low and even negative rates.

The move, along with investors' concerns about tech and other macro themes, sent global stock markets tumbling on Monday.

On Wednesday, Shinichi Uchida, a deputy governor at the Bank of Japan, said the central would not hike interest rates when the financial and capital markets are unstable.

"I believe that the Bank needs to maintain monetary easing with the current policy interest rate for the time being, with developments in financial and capital markets at home and abroad being extremely volatile," said Uchida at a local event in Hokkaido.

The comments were "a strong dovish signal" that played down the chances of near-term rate hikes amid such volatile markets, wrote Jim Reid, a strategist at Deutsche Bank, on Wednesday.

Uchida's statement came after Monday's massive meltdown in the global stock market that some analysts blamed on the Japanese central bank's rate hike last week that unraveled yen carry trades.

This tipped global markets over the edge amid existing concerns over the US economy, cooling enthusiasm for AI, and geopolitical concerns.

It's not the first time Japanese officials have sought to calm the market turmoil that sent the Nikkei to its worst one-day percentage loss since Black Monday in 1987.

On Tuesday, Japanese officials from its finance ministry, financial regulator, and BOJ met to discuss the massive sell-off. Prime Minister Fumio Kishida himself urged calm.

Uchida's dovish signal on Tuesday boosted Asian shares.

Japan's benchmark Nikkei 225 index jumped as much as 4% by 2.45 p.m. local time. Since its rebound yesterday, it has regained nearly all its losses on Monday. Meanwhile, the yen lost over 2% against the US dollar.

South Korea's Kospi gained as much as 2.6%, while Taiwan's Taiex closed nearly 4% higher.

Australia's ASX 200 closed 0.3% higher.

Yen carry trade risks remain

Despite the BOJ cooling attitude on rate hikes — at least for now — there are still risks associated with the yen carry trade, which could further unwind if the Fed cuts rates rapidly.

The trading strategy involves borrowing cheaply in Japan's ultra-low interest rate environment and using the funds to invest in higher-yielding, such as US tech stocks, elsewhere.

Nobody seems to know how much carry trade is at stake.

As Macquarie's analysts wrote in a Tuesday note. "We do not profess to have all of the answers as to the breadth and depth of the unwind of the yen carry trade."

Bloomberg estimates there could be trillions at stake, pointing to potential complications. A JPMorgan strategist has said that the carry trade unwind is only half done.

It could complicate the the Fed's interest rate decisions. The US central bank recently signaled that it could start cutting rates as soon as September.

"The natural reaction from the Fed to soft labour market data and fresh recession risks would be to cut rates and to do so relatively rapidly. But this would exacerbate any carry trade unwind," wrote analysts at GlobalData.TS Lombard in a Monday note.