January 24, 2025. At today's Bank of Japan Monetary Policy Meeting, the BOJ decided to raise interest rates. However, at this point, the reaction in the USD/JPY exchange rate in the foreign exchange market has been limited. Due to this monetary policy change, Japan's policy interest rate has reached its highest level in 30 years since 1995, but from a long-term perspective, it is predicted that the dollar-strong trend will likely continue. As evidence for this, we will analyze the U.S. policy interest rates, 2-year bond yields, and the occurrence and resolution of the inverted yield curve between 2-year and 10-year bond yields.

■Occurrence and Convergence of Inverted Yield Curve

　The charts at the beginning show graphs of policy interest rates and 10-year government bond yields in Japan and the United States, as well as U.S. 2-year and 10-year government bond yields respectively. Looking at the center and right charts, something peculiar occurred in the interest rate markets over the past six months. Despite the Fed entering a rate-cutting phase from the latter half of 2024 and implementing four rate cuts in a relatively short period, 10-year government bond yields rose. This is said to be partly due to inflation expectations accompanying predictions of the Trump administration's emergence. However, taking a longer-term view reveals an even more unusual situation: the inversion phenomenon between U.S. short-term policy rates or 2-year government bond yields and 10-year government bond yields, known as an inverted yield curve.

■The inverted yield curve occurred from the end of 2022 and was resolved after Trump's election victory through the New Year.

　Normally, long-term funding carries higher risks, so long-term interest rates typically exceed short-term rates. However, in the United States, this inverted state continued for over a year from 2022 to early 2023 when comparing policy rates or 2-year and 10-year government bond yields.

　The background for this inverted yield curve can be attributed to the rapid rate hikes implemented by the Fed from the first half of 2022 to suppress inflation. The Fed raised policy rates to over 5% in just 18 months after starting rate hikes. This was because U.S. inflation rates were growing at a pace that seemed likely to reach double digits. However, despite the rapid rate hikes, the U.S. economy remained robust and inflation rates did not subside. As a result, from early 2023, 10-year bond yields could not keep pace with the rise in policy rates, leading to a prolonged inverted yield curve.

■While the mechanism of inverted yield curve occurrence and resolution cannot be fully explained, it is natural that policy effects are limited if market interest rates do not rise.

　This phenomenon may have been influenced by the special ownership structure of U.S. Treasuries (large-scale holdings by overseas investors, including Japan and China). Additionally, the market's judgment that policy rates were too high, leading to fund inflows into long-term bonds, was also a contributing factor. While it is difficult to pinpoint the exact causes and background of the inverted yield curve, what is clear as a policy consequence is that it was natural that inflation could not be curbed if market interest rates did not follow even when policy rates were raised.

■U.S. interest rate trends may be moving toward "normalization" rather than abnormal movements

However, from mid-2024 onwards, the inverted yield curve began to resolve. This was because 10-year bond yields rose while the Fed rapidly lowered policy rates due to concerns about slowing inflation and economic recession. Trump's election victory and the reduction of geopolitical uncertainties may have also had an impact. As a result, from the end of 2024 to early 2025, this inverted yield curve in the United States has been resolved, creating a normal yield curve state where 10-year bond yields exceed policy rates. If the theory that a normal yield curve is more natural than an inverted one is correct, then the current level of U.S. 10-year bond yields can be said to be moving toward "a level consistent with policy" rather than "an abnormal level."

Furthermore, the magnitude of the U.S. normal yield curve remains smaller compared to Japan (the left chart shows Japan), and it would not be unusual for the spread to widen a bit more. This may suggest that there is room for U.S. 10-year bond yields to rise further.

■U.S. interest rates will remain elevated at current levels, and Japanese rates will not rise rapidly.

On the other hand, looking at Japan's situation, although the Bank of Japan decided to raise rates today, it appears that the rate hike was already considerably priced into the market. Therefore, the possibility of Japan's 10-year bond yields rising sharply in the future is low. This makes it unlikely that the Japan-U.S. interest rate differential (here, the difference in 10-year bond yields) will narrow rapidly, and as a result, the dollar-strong trend is predicted to continue.

　Looking at U.S. policy, while Trump has indicated intentions to revive manufacturing, this represents a major industrial structural reform requiring a span of more than 10 years. Rather, expanding crude oil extraction would be more likely to produce effects in a shorter timeframe. Trump, or Bessent who is responsible for economic management, will likely take stronger action to check dollar strength only after assessing the inflation-suppressing effects of increased crude oil production. This is expected to be at least one to three years or more in the future.

■The Relationship Between Inverted Yield Curves and Recession (Horror Story)

　Incidentally, it is empirically known that in past U.S. cases where inverted yield curves occurred (such as inversions between 2-year and 10-year government bond yields), the economy sometimes fell into recession. More precisely, recessions have been observed after inverted yield curves occurred and were subsequently resolved. Specifically, these include the stagflation recession of the early 1980s, the IT bubble collapse recession of the early 2000s, and the Lehman Shock recession of 2008. In all cases, inverted yield curves occurred first, and recessions happened after they were resolved.

　Whether the resolution of the inverted yield curve in U.S. markets from the latter half of 2024 to early 2025 is a harbinger of recession is unknown. However, it is worth keeping in mind that such relationships have been observed in past cases. Should the United States fall into recession, it would lead to a significant decline in interest rates, and at that time, rapid yen appreciation could occur. However, whether this will happen is unknown to anyone. Black swans may truly exist, but believing in their existence can also be dangerous.