Yen Carry Trade Under Pressure as Japan's Two-Year Yield Hits 31-Year High

Japan's two-year government bond yield hit a 31-year high on Monday at 1.746%, prompting concerns about the yen carry trade and its impact on global risk assets, including Bitcoin (BTC). The move raises the cost of borrowing yen to fund investments abroad, which could lead to forced selling in markets.

The Bank of Japan's (BOJ) policy rate increase to 1% in June and subsequent hikes have narrowed the spread between US and Japanese two-year yields to 2.64%, down from a peak of close to 5%. This reduction in the carry incentive has contributed to the yen's weakness, despite Tokyo's deployment of $97 billion in July and August.

The divergence between the yen's decline and the shrinking reward for borrowing yen suggests that interest rates are not the main driver of the currency's movement. Mounting Japanese bond losses and heavy debt issuance indicate a confidence problem that higher rates alone cannot solve.

For investors, the yen carry trade involves borrowing yen cheaply to buy higher-yielding assets abroad. However, sharp yen appreciation makes those loans costlier to repay, leading to forced selling in markets. A similar scenario played out in August 2024, where Bitcoin and Ethereum lost as much as 20% due to yen-funded positions being closed.