Could Japan trigger another yen carry trade shock for Bitcoin?

The Japanese yen has fallen past 158 against the dollar after traders cut expectations for another Bank of Japan rate hike this month, keeping yen funded carry trades attractive for now while raising the risk of another abrupt reversal that could spill into Bitcoin and the crypto market.

According to CNBC, the yen fell as much as 0.5% to 158.21 per dollar on Oct. 1 and was the worst performer among Group of 10 currencies after the BOJ released a summary of opinions from its September meeting.

Traders had been looking for stronger signals that policymakers were preparing to raise rates again in October. Instead, swaps pricing for a hike by Oct. 30 fell below 20% from more than 30% a day earlier, while another move was fully priced by December.

A weaker yen does not by itself signal that carry trades are unwinding. It can make the strategy more attractive because investors can borrow in yen and move that capital into currencies and assets offering higher returns.

The risk comes if the yen suddenly reverses course.

Yen carry trade remains vulnerable to a sudden reversal

Japan has spent years providing one of the cheapest major sources of funding for global investors, allowing traders to borrow yen and deploy the money into higher yielding assets overseas.

As crypto.news previously reported in its coverage of Japan’s multi decade high bond yields, higher Japanese borrowing costs have begun putting pressure on that trade as the BOJ moves away from the ultra low rate environment that supported it.

Japan’s 10 year government bond yield recently reached 3.075%, its highest level since 1996, after the BOJ raised its policy rate to 1.25% in September. Higher domestic yields can make Japanese assets more competitive and reduce the incentive to borrow yen to invest overseas.

So far, the adjustment has not turned into a disorderly unwind. The yen weakened after the September rate decision and has now fallen beyond 158 per dollar, leaving a sizeable interest rate gap between Japan and the United States.

BOJ policymakers are still discussing more tightening.

The September meeting summary showed that several members wanted borrowing costs moved higher, with one policymaker saying the bank may need to accelerate rate hikes if inflation begins moving above its expected path.

Another member said bringing the policy rate closer to its approximate goal relatively soon would give the BOJ more room to respond to economic developments.

Two members dissented from the September hike, while other opinions pointed to weak consumption and slower services inflation as reasons to proceed carefully.

Takuya Kanda, senior FX analyst at Gaitame.com Research Institute, said the opinions were hawkish but not enough to strengthen expectations for consecutive rate hikes.

“If dollar yen rises above 158, intervention concerns are likely to cap the dollar’s upside,” Kanda said.

Intervention could change the yen carry trade quickly

Currency intervention has become another risk for traders betting against the yen.

Japan and the United States conducted a rare coordinated intervention on July 31 after the yen fell close to 40 year lows, buying the Japanese currency in an effort to prevent the slide from destabilizing financial markets.

Japan’s top currency diplomat Atsushi Mimura warned this week that markets should take recent messages from Tokyo and Washington on the yen “at face value.”

Mimura declined to say whether authorities would intervene again, but said he was neither satisfied nor reassured by the currency’s recent moves.

A new intervention could matter for carry trades because traders borrowing yen face currency risk as well as borrowing costs. A rapid rise in the yen makes repayment more expensive and can force leveraged investors to close positions.

Those exits require investors to sell assets bought with the borrowed money and purchase yen to repay their liabilities. If enough positions are closed at once, the process can feed on itself as yen buying pushes the currency higher and puts more pressure on remaining carry trades.

Markets saw a similar mechanism during the August 2024 selloff.

The Bank for International Settlements later estimated a rough middle range of around ¥40 trillion, or $250 billion at the time, for carry trade exposure heading into the episode, while noting that data gaps meant the estimate could understate the true size.

Its analysis found that leveraged trades across equity and currency markets amplified the initial market reaction as investors reduced exposure and margin requirements rose.

Bitcoin has been hit by yen carry trade unwinds before

Crypto markets were caught in the 2024 deleveraging as investors sold liquid risk assets.

A yen carry trade analysis published after the episode showed that total crypto market capitalization fell from roughly $2.16 trillion to $1.78 trillion during the Aug. 5 selloff, a drop of nearly 18%.

Bitcoin fell to around $49,000 during the turmoil before recovering in the following days.

The transmission does not require investors to have directly borrowed yen to purchase Bitcoin. Carry trade stress can force leveraged investors to reduce positions across markets as they raise cash, meet margin requirements or repay yen denominated liabilities.

Crypto can react quickly during such episodes because Bitcoin, Ethereum and other major tokens trade around the clock.

Similar concerns resurfaced this year as Japan continued raising rates. When the BOJ lifted its benchmark rate to 1% in June, crypto traders watched Japan for signs that higher borrowing costs could pressure yen funded positions.

Bitcoin had previously fallen roughly 3% within hours of the BOJ’s January rate increase to 0.75%, though the move alone did not establish that carry trade liquidation was responsible for the decline.

Following the BOJ’s Sept. 18 rate hike, Bitcoin climbed above $77,000 while the yen weakened. The reaction avoided the combination of a stronger yen and higher Japanese rates that can put more immediate pressure on carry positions.

Yen weakness keeps the trade alive for now

Current conditions therefore differ from a classic carry trade unwind.

The yen’s fall past 158 means investors borrowing the Japanese currency are not yet facing the exchange rate shock that typically forces positions to close. Expectations for an immediate BOJ hike have fallen at the same time, easing one source of pressure on borrowing costs.

Japanese government bond yields are moving in the other direction.

Longer dated yields rose after the latest BOJ summary, while Japan’s 10 year yield remains around levels not seen in three decades. Higher yields could gradually make keeping capital in Japan more attractive even without a sudden currency move.

The BOJ’s quarterly Tankan survey gave policymakers another reason to avoid rushing into an October hike. Confidence among large manufacturers reached its highest level in more than eight years, but the survey showed little evidence that inflation pressure was accelerating.

Taro Kimura, senior Japan economist at Bloomberg Economics, said the results lowered the probability of consecutive rate increases in October.

For yen funded traders, intervention remains the more immediate currency risk if USD/JPY continues climbing.

Japanese financial authorities reportedly conducted a rate check during New York trading after the September BOJ meeting as the yen weakened. Such checks can precede intervention, though they do not guarantee authorities will enter the market.

Mimura said Japan did not face funding constraints that would prevent another intervention and pointed to the July operation as evidence of close cooperation between Tokyo and Washington.

Meanwhile, the BOJ has left further tightening on the table. Most opinions in its September meeting summary supported additional rate hikes, while policymakers debated how quickly borrowing costs should move toward levels that no longer provide as much support to the economy.

Carry traders now face the risk of borrowing costs rising further in Japan, while any intervention by authorities could send the yen higher and put more pressure on their positions.