Bitcoin isn’t the only asset taking a beating this quarter.
The Japanese yen (JPY) also fell by 157.20 per US dollar, a big move for a major fiat currency, prompting currency traders to await intervention from the Bank of Japan (BOJ) to stem the decline.
But why are we discussing FX? That’s because, historically, yen weakness has been associated with risk-on sentiment – when traders borrow the yen at low interest rates in Japan and convert it into other currencies, such as the US dollar, to invest in higher-yielding assets. This activity puts downward pressure on the yen.
A falling yen further increases this dynamic, as it means fewer dollars are needed to repay the yen loan, thereby increasing the overall profitability of the carry trades.
Conversely, a strengthening yen weakened the appeal of carry trades and signaled broad-based risk-off. For example, during the August 2024 crash, bitcoin fell from around $65,000 to $50,000 in a week. It came as the BOJ raised interest rates for the first time in a decade, pushing the yen higher.
So it’s natural to instinctively think that the recent 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 trades. There are reports of Japanese retail investors chasing the high-yielding Turkish lira.
That said, Japan, which is facing debt problems, no longer offers the stable macroeconomic environment that once supported the yen’s role as both a base currency and a safe haven. This reality challenges the likelihood of a broad increase in yen-financed carry trades and risk-on sentiment across financial markets, including BTC and altcoins.
Fiscal stress causes yen volatility
Experts say the yen’s ongoing slide reflects the underlying fiscal strain manifesting in the currency market.
Japan is one of the most indebted nations worldwide, with a debt-to-GDP ratio of around 240%. Concerns about this have intensified amid the post-Covid inflation spike and the newly elected prime minister’s promise of expansionary fiscal policy, which means more borrowing, more debt issuance and higher interest rates. 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 woes and inflation worries have already lifted the 10-year Japanese government bond yield, which remained near or below zero for nearly six years until 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 total breakdown in the positive yield-currency correlation, a sign that fiscal policy issues are dominating market sentiment.
In essence, Japan is now in a corner: it risks a full-blown fiscal crisis if it allows interest rates to keep rising. At the same time, it faces a complete yen crash and a rise in imported inflation if it lowers interest rates and keeps them lower.
As economist Robin Brooks, senior fellow in the Global Economy and Development Program at the Brookings Institution, put it: “If Japan stabilizes the yen by letting interest rates rise, there is a fiscal crisis. If it keeps interest rates low, the yen goes back into a devaluation spiral. Too much debt is a killer…”
All of this means the potential for high volatility in the yen, undermining 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.
Swiss franc, a better risk barometer
Meanwhile, currencies like 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 looks more attractive as a carrier currency than the yen, as Switzerland’s benchmark interest rate is 0%. If that’s not enough, the 10-year Swiss government bond yield is hovering at 0.09%, the lowest among developed economies, according to TradingView.
This means that going forward, BTC traders may be better off tracking CHF pairs for broad risk-on/risk-off signals.
