Rising Yield on Japan's 2-Year Bonds; Does Yen Carry Trade Threaten Bitcoin Again?
The yield on Japan's two-year government bonds reached 1.746% on Monday, the highest level in over 31 years. This increase comes as markets are highly anticipating another interest rate hike by the Bank of Japan (BOJ) in September; an event that could raise the cost of borrowing yen in transactions known as "yen carry trade" and, if capital outflows intensify, could pose challenges for riskier assets like Bitcoin.
According to Mihan Blockchain, traders are currently factoring in an approximately 88% chance of an interest rate increase in Japan in September. This probability indicates that a significant portion of the market expects the Bank of Japan to tighten its monetary policy again at its next meeting. However, the main issue is not just the central bank's next decision; the ongoing weakening of the yen despite these policies suggests that deeper factors are influencing the Japanese currency market.
In June, the Bank of Japan raised its policy interest rate to 1%, the highest level since 1995. The yield on long-term bonds also continued to rise, with the yield on Japan's 10-year government bonds reaching about 2.93%.
Despite the interest rate hike, the yen did not strengthen as expected. The dollar's rate against the yen reached 160.16 yen on Friday and again advanced to 160.20 yen on Monday.
To combat the decline in the value of the national currency, the Japanese government spent about 15.4 trillion yen, equivalent to nearly $97 billion, between July 30 and August 26. These actions even included a rare joint intervention with the United States on July 31. However, the yen has so far lost more than half of the gains made as a result of these interventions.
One significant factor in market developments is the narrowing interest rate gap between the U.S. and Japan. The yield difference on two-year bonds between the two countries is now about 2.64%, while this gap peaked at nearly 5% during 2023 and 2024.
This difference has been one of the main pillars of the yen carry trade for years; a strategy in which investors borrow yen at low costs and transfer capital to higher-yielding assets in other countries. As the interest rate gap narrows, the incentive to continue these trades also decreases.
However, recent currency market behavior does not align with this pattern. The yen continues to weaken even as its interest rate advantage diminishes. This divergence indicates that other factors, including concerns about the state of Japan's bond market, high debt issuance, and investor confidence in the country's financial situation, may play a more significant role in determining the yen's value.
The yen carry trade is not just a trading strategy in the currency market, and its implications can spill over into global markets. Investors can use cheap yen borrowing to invest in assets like stocks, cryptocurrencies, and other risky assets.
Problems arise when the yen strengthens rapidly. In such cases, the cost of repaying yen loans increases, and traders may be forced to sell assets purchased in other markets to close their positions.
The crypto market experienced a clear example of this risk in August 2024. With renewed concerns about a potential interest rate hike in Japan and a strengthening yen, some yen-funded trades were closed, causing the prices of Bitcoin and Ethereum to drop by about 20% at one point.
Meanwhile, the market has largely priced in the likelihood of an interest rate hike in Japan in September. Therefore, if the Bank of Japan acts as expected, the rate hike itself is unlikely to create a significant shock for the market.
The main risk could arise from elsewhere: the volume of trades that are still based on yen financing. If Japan's monetary policy becomes tighter than investors expect or if the yen strengthens rapidly against the current trend, the likelihood of forced closures of some of these positions increases.
In such a scenario, Bitcoin and other risky assets could come under selling pressure. Thus, the September decision by the Bank of Japan may be more than just an interest rate event; it could serve as an indicator for assessing the status of one of the most important sources of liquidity in global markets.
-- Price
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