Bitcoin Rises on Dollar Weakness... Next Challenge is Yen Strength

[By Myungjeong Sun, Block Media] Amid expectations of policies aimed at curbing the rise in long-term U.S. interest rates and the weakness of the dollar, Bitcoin has been supported in its rise, while a variable from Japan has emerged as a new challenge. This is due to the Japanese government bond yields soaring to their highest levels in nearly 30 years, increasing the likelihood of further interest rate hikes by the Bank of Japan (BOJ).

Currently, the yen has weakened again to around 159 yen per dollar, reducing the pressure for unwinding yen carry trades. Bitcoin has recently risen over 20% in the past week, effectively ignoring the instability in the Japanese bond market.

However, both the U.S. and Japan are wary of excessive yen weakness. If the BOJ raises interest rates or intervenes in the foreign exchange market, the yen could rapidly strengthen, leading to a swift unwinding of carry trades that borrowed yen to invest in U.S. stocks and digital assets.

This suggests that while Bitcoin has risen on the 'medicine' of dollar weakness, yen strength could emerge as a new 'challenge'.

Japanese Government Bond Yields at 30-Year High... Possibility of BOJ Rate Hike in September

According to Bloomberg and Reuters on the 23rd (local time), the yield on Japan's 10-year government bonds rose to 2.945% during trading, the highest level since September 1996. On the same day, the yield on 30-year bonds also soared to 4.115%.

The rise in Japanese government bond yields is driven by inflationary pressures. Japan's core inflation rate in July rose to 1.8%, up from 1.6% in June. The inflation rate excluding food and energy also recorded 1.9%.

The market interprets this as a signal that the BOJ may step back from its ultra-low interest rate policy. The BOJ will hold a monetary policy meeting on September 17-18, and the market is watching for the possibility of raising the policy rate from the current 1% to 1.25%.

The rise in Japanese interest rates also affects the value of the yen. As the interest rate differential between Japan and the U.S. narrows, the attractiveness of borrowing low-interest yen to invest in dollar-denominated assets decreases.

However, the foreign exchange market is currently showing the opposite trend. After recent interventions, the yen strengthened to 155.20 per dollar but has since weakened back above 158 yen to around 159 yen, effectively reversing much of the yen's strength seen during the intervention.

As a result, the unwinding of yen carry trades has not yet begun in earnest. Bitcoin is trading around $77,000, having risen about 22% over the past week.

The question is whether the current weakness of the yen will continue in the future.

Both the U.S. and Japan do not want excessive yen weakness, and if the BOJ raises rates or if the U.S. and Japanese authorities respond with policies, the direction of the yen could quickly reverse.

Dollar Weakness Was 'Medicine'... Yen Surge Could Trigger Carry Trade Unwinding

The macro environment that has recently favored Bitcoin is centered around the U.S.

As the U.S. Treasury expands its long-term bond buyback program, expectations have formed that there is a strengthened policy intent to curb the rise in long-term interest rates. With concerns about further increases in U.S. long-term rates easing and the dollar showing weakness, an environment has been created for funds to flow into risk assets like Bitcoin.

Bitcoin's recent rise of over 20% in the past week is not unrelated to these liquidity expectations.

However, a potential yen strength from Japan could impact Bitcoin through a different channel than dollar weakness.

The key is the yen carry trade.

As Japan has maintained ultra-low interest rates for an extended period, global investors have borrowed yen at low costs, converting them into dollars to invest in relatively higher-yielding assets like U.S. stocks and bonds. When risk appetite is strong, digital assets are also influenced by this global liquidity.

According to reports citing data from the Bank for International Settlements (BIS), the amount of yen loans supplied to non-bank entities overseas is about $250 billion. Broader estimates suggest it could reach around $500 billion.

If the yen remains weak or stable, these trades can be maintained. Conversely, if the value of the yen surges sharply in a short period, investors will incur exchange rate losses. Additionally, if the BOJ raises interest rates, the cost of borrowing yen will also increase, simultaneously deteriorating the profit structure of carry trades.

Ultimately, investors will sell existing assets like U.S. stocks or digital assets to buy yen and repay their borrowings. Yen strength could lead to the selling of risk assets, triggering a deleveraging process that reduces positions.

For Bitcoin investors, what matters is not just whether the dollar weakens, but how quickly the dollar-yen exchange rate declines.

Bitcoin Could Plunge to $49,000 by August 2024

The reason the market is wary of yen movements is due to similar past experiences.

In August 2024, when the yen rapidly strengthened, concerns about unwinding yen carry trades spread across the global financial markets. At that time, Bitcoin started at around $64,600 in early August and fell to $49,000 during trading five days later. The Japanese TOPIX index also dropped 12% in just one day.

The key point then was that it was not a strong dollar that caused the collapse of risk assets. As concerns about a slowdown in the U.S. economy and expectations for interest rate cuts by the Federal Reserve grew, the dollar itself faced downward pressure.

However, the yen strengthened much more quickly than the dollar.

While a weak dollar typically creates a favorable environment for Bitcoin and U.S. growth stocks, the shock from unwinding carry trades due to a surging yen overwhelmed this. In the process of global investors reducing leverage, both Bitcoin and stocks were sold off together.

The same logic could apply in the current market.

If the dollar weakens gradually and the yen also strengthens slowly, there is no compelling reason to view it as negative for Bitcoin. The burden of U.S. interest rates would decrease while carry trades could also be adjusted gradually.

Conversely, if the BOJ raises rates or intervenes in the foreign exchange market, causing the yen to surge sharply in a short period, the situation changes. The liquidity effect provided by dollar weakness could be outweighed by the selling pressure from unwinding carry trades.

Not Just Bitcoin, U.S. Stock Market is Also at Risk... Key is 'Speed of Yen Strength'

The U.S. stock market is also not free from the same risks.

Dollar weakness and falling long-term U.S. interest rates are generally favorable for the U.S. stock market. In particular, falling rates increase the present value of future profits, reducing the valuation burden on tech and growth stocks. Dollar weakness can also positively impact the performance of U.S. multinational companies with high overseas sales proportions.

However, if the yen surges sharply and carry trades are unwound, position reductions could also occur in the U.S. stock market. Growth and tech stocks, which are particularly sensitive to leverage and risk appetite, may be affected in the short term.

The Japanese stock market is likely to be more directly impacted. Yen weakness enhances the price competitiveness of Japanese export companies and increases the yen-denominated value of profits earned overseas. Conversely, if the yen strengthens rapidly, it could burden the earnings expectations of export companies like automotive and electronics.

Ultimately, two opposing forces are simultaneously at work in the global market.

In the U.S., easing long-term interest rate burdens and dollar weakness are pushing up risk assets. Meanwhile, in Japan, rising government bond yields and the possibility of further tightening by the BOJ are increasing the likelihood of yen strength and a reduction in global carry trades.

So far, expectations for liquidity from the U.S. have prevailed. Bitcoin has risen to around $77,000, and the U.S. stock market has maintained high levels as a backdrop.

The next turning point is expected to be the BOJ's monetary policy meeting in September. If the BOJ raises the policy rate from 1% to 1.25% as the market expects, how quickly the dollar-yen exchange rate reacts will be crucial.

Therefore, the most favorable scenario for Bitcoin investors is not simply a continuation of 'yen weakness'. It is a situation where U.S. long-term interest rates and the dollar gradually decline while the yen normalizes without causing a sharp unwinding of carry trades.

Conversely, if the policy responses from U.S. and Japanese authorities, who do not want yen weakness, are stronger than expected, leading to a rapid surge in the yen, it could become a new challenge for the recent Bitcoin rally. If dollar weakness from the U.S. has been the driving force behind Bitcoin's rise, the market's focus will now shift to how much the yen strength from Japan offsets that effect.