- The Bank of Japan (BOJ) is set to raise interest rates next week, raising concerns of a Japanese yen surge and carry trade unwind.
- Japanese interest rates after the hike will still be low compared to U.S. rates, keeping carry trade incentives intact.
- Markets have already priced in the BOJ rate hike, with Japanese government bond yields near multi-decade highs.
- Speculators hold net long positions on the yen, indicating limited potential for panic-driven yen buying.
- The main risk is sustained global bond yield increases from Japanese tightening, potentially impacting risk assets.
The Bank of Japan (BOJ) plans to increase interest rates next week. This has led to concerns that the Japanese yen might strengthen sharply, causing an unwinding of carry trades and pressure on assets like Bitcoin. Carry trades involve borrowing yen at low interest rates and investing in higher-yielding assets abroad.
For decades, Japan’s near-zero interest rates encouraged investors to borrow yen and invest in U.S. technology stocks and Treasury bonds. According to Charles Schwab, “Going long on tech and short on the yen were two very popular trades” due to the yen’s status as a low-cost funding currency.
However, even after the expected BOJ rate hike to 0.75% (around $0.75), U.S. rates remain significantly higher at 3.75%. This difference still favors investing in U.S. assets, reducing the likelihood of large-scale carry trade unwinding. Additionally, the rate increase is well-anticipated; Japanese government bond (JGB) yields are near 1.95%, more than double the projected official BOJ rate.
Market expert Eamonn Sheridan said, “Japan’s 1.7% JGB yield isn’t a surprise. It has been in forward markets for more than a year, and investors have already repositioned for BOJ normalization since 2023.” This suggests the rate hike’s impact is already reflected in market prices.
Speculators have held net long yen positions since February this year, as data from Investing.com shows. This contrasts with mid-2024, when bearish yen positioning led to sharp yen appreciation after a smaller rate rise. Back then, the 10-year JGB yield was near 1%, causing a sudden market reaction. Currently, yields remain elevated and rising gradually, lessening the chance of a shock.
The yen’s role as a market risk indicator faces competition from the Swiss franc, which provides stable yields with lower volatility. The BOJ rate adjustment may increase volatility but is unlikely to cause severe disruptions.
The primary concern is that ongoing Japanese monetary tightening could keep U.S. Treasury yields high, counteracting expected Federal Reserve rate cuts. Persistent high bond yields typically increase borrowing costs and may suppress valuations of stocks and cryptocurrencies. Another macro factor to watch is global fiscal expansion efforts that might lift bond yields and cause risk aversion.
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