bitcoin is not the only asset that has taken a beating this quarter.
The Japanese yen (JPY) is also down 157.20 per US dollar, a big move for a major fiat currency, leading currency traders to hope for intervention from the Bank of Japan (BOJ) to stem the slide.
But why are we talking about currencies? This is because yen weakness has historically been linked to risk-on sentiment – when traders borrow yen at low interest rates in Japan and convert them into other currencies, such as the US dollar, to invest in higher-yielding assets. This activity puts downward pressure on the yen.
A fall in the yen further drives this dynamic as it means that fewer dollars are needed to repay the yen loan, thus increasing the overall profitability of carry trades.
In contrast, a strengthening yen affected the attractiveness of carry trades and signaled widespread risk aversion. For example, during the August 2024 crisis, bitcoin fell from approximately $65,000 to $50,000 over the course of a week. That happened as the Bank of Japan raised rates for the first time in a decade, sending the yen higher.
Therefore, it is natural to instinctively think that the latest drop in the yen is good news for BTC and risk assets in general. After all, the BOJ’s official interest rate currently stands at 0.5%, compared to 4.75% in the US, creating a strong incentive for carry-trading. There are reports of Japanese retail investors chasing the high-yielding Turkish lira.
That said, Japan, facing debt problems, no longer offers the stable macroeconomic environment that once underpinned the yen’s role as a carry and safe haven currency. This reality challenges the likelihood of a widespread increase in yen-financed carry trades and risk sentiment in financial markets, including BTC and altcoins.
Fiscal tension causes volatility in the yen
Experts say the current decline in the yen reflects the underlying fiscal stress playing out in the currency market.
Japan is one of the most indebted nations in the world, with a debt-to-GDP ratio of around 240%. Concerns about this have intensified amid rising post-COVID inflation and the newly elected Prime Minister’s promise of expansionary fiscal policy, meaning more borrowing, more debt issuance and higher yields. Just today, the government approved a $135 billion fiscal stimulus package.
This means that the path of least resistance for Japanese government bond yields is on the higher side. Fiscal issues and inflation concerns have already pushed the yield on 10-year Japanese government bonds, which remained near or below zero for nearly six years through 2022, to 1.84%, the highest level since 2008.
The 20- and 30-year yields are also hovering around multi-decade highs, along with a weakening yen, marking a complete break in the positive correlation between yields and the exchange rate, a sign that fiscal issues are dominating market sentiment.
In essence, Japan is now cornered: it risks a full-blown fiscal crisis if it allows yields to continue rising. At the same time, it faces a complete collapse of the yen and a rise in imported inflation if it caps yields and keeps rates low.
As economist Robin Brooks, senior fellow in the Global Economics and Development program at the Brookings Institution, put it: “If Japan stabilizes the yen by allowing yields to rise, a fiscal crisis ensues. If it keeps rates low, the yen spirals back into devaluation. Too much debt is deadly…”
All of this means potential for high volatility in the yen, weakening its historical appeal as a funding and safe haven currency, and a macroeconomic environment that is not as conducive as it used to be for traders to consider the yen as a funding currency.
The Swiss franc, a better risk barometer
Meanwhile, currencies like the Swiss franc are emerging as new carry bets, as Marc Chandler, chief market strategist at Bannockburn Global Forex, told CoinDesk earlier this year.
The CHF appears more attractive as a carry currency than the yen, as Switzerland’s benchmark interest rate is 0%. If that weren’t enough, the 10-year Swiss government bond yield is around 0.09%, the lowest among developed economies, according to TradingView.
It means that in the future, BTC traders are better off following CHF pairs for broad risk/risk aversion signals.
