Bitcoin is not the only asset to be beaten this quarter.
The Japanese yen (JPY) is also down 157.20 per US dollar, a significant move for a major fiat currency, prompting foreign exchange traders to await intervention from the Bank of Japan (BOJ) to stem the decline.
But why are we talking about FX? That’s because, historically, yen weakness has been linked to risk sentiment – when traders borrow yen at low interest rates in Japan and convert it into other currencies, like the U.S. dollar, to invest in higher-yielding assets. This activity puts downward pressure on the yen.
A decline in the yen further reinforces this dynamic, because it means that fewer dollars are needed to repay the yen loan, thereby increasing the overall profitability of carry trades.
Conversely, the strengthening of the yen diminished the appeal of carry trades and signaled widespread risk aversion. For example, during the August 2024 crash, bitcoin went from around $65,000 to $50,000 in one week. This came as the BoJ raised rates for the first time in a decade, pushing the yen higher.
It is therefore natural to instinctively think that the latest decline 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. Japanese retail investors are reportedly seeking the high-yielding Turkish lira.
That said, Japan, facing debt problems, no longer offers the stable macroeconomic environment that once supported the yen’s role as both a carry currency and a safe haven. This reality calls into question the likelihood of a widespread increase in yen-funded carry trades and risk sentiment across financial markets, including BTC and altcoins.
Fiscal tensions cause yen volatility
Experts say the yen’s continued decline reflects underlying fiscal tensions playing out in the foreign exchange market.
Japan is one of the most indebted countries in the world, with a debt-to-GDP ratio of around 240%. Concerns about this have intensified amid the post-Covid inflation surge and the recently 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 plan.
This means that the path of least resistance for Japanese government bond yields is upward. Fiscal woes and inflation fears have already pushed the yield on Japan’s 10-year government bonds, which has remained near or below zero for almost six years through 2022, to 1.84%, the highest level since 2008.
20- and 30-year yields are also hovering at multi-decade highs alongside a weakening yen, marking a complete breakdown in the positive correlation between yield and 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 to rise. At the same time, he will face a real crash in the yen and a surge in imported inflation if he caps yields and keeps rates low.
As economist Robin Brooks, a senior fellow in the Global Economy and Development program at the Brookings Institution, says: “If Japan stabilizes the yen by allowing yields to rise, there will be a fiscal crisis. If it keeps rates low, the yen falls back into a devaluation spiral. Too much debt is deadly…”
All of this means the potential for high volatility in the yen, which weakens its historical appeal as a financing and safe-haven currency, and a macroeconomic environment, which is no longer as conducive as before for traders to consider the yen as a financing currency.
The Swiss franc, a better barometer of risk
Meanwhile, currencies such as the Swiss franc are emerging as new carry plays, as Marc Chandler, chief market strategist at Bannockburn Global Forex, told CoinDesk earlier this year.
The CHF seems more attractive as a carry currency than the yen, since the reference interest rate in Switzerland is 0%. As if that wasn’t enough, the yield on 10-year Swiss government bonds is hovering at 0.09%, the lowest among developed economies, according to TradingView.
This means that in the future, BTC traders might be better off tracking CHF pairs for general risk aversion cues.
