Speculation on interest rate increases is growing for the Federal Reserve and the Bank of Japan as well.

A declining yen, increasing bond yields, and the potential for a carry trade unwind present challenges for risk assets, including bitcoin.

Close up of the red circle at the center of the Japanese flag. (DavidRockDesign/Pixabay)

Key points:

• The yen’s prolonged weakness near 160 against the U.S. dollar is intensifying pressure on the Bank of Japan to further increase interest rates.
• Japanese government bond yields, with the 40-year yield exceeding 4%, indicate tightening conditions, and historical instances show that rising Japanese rates can lead to significant crypto sell-offs.

The possibility of interest rate hikes is no longer limited to the U.S. scenario. Traders are beginning to speculate that the Bank of Japan (BoJ) may also tighten as the resource-limited country confronts inflation risks stemming from the ongoing conflict in Iran.

Market participants estimate a roughly 69% likelihood of the BoJ increasing its benchmark borrowing rate at the meeting scheduled for April 28, according to data monitored by Bloomberg. Options activity related to U.S. interest rates suggests traders anticipate the Federal Reserve will raise borrowing costs in the near term.

The summary from the BoJ’s policy meeting released on Monday revealed that one member advocated for a more substantial rate hike in response to the Middle East conflict and its inflationary effects on Japanese society. The remarks also indicated that any decision would consider forthcoming economic data and anecdotal evidence from the market.

The Fed’s tightening is a widely recognized headwind for risk assets, including bitcoin. The Bank of Japan can exert a similar influence. Years of extremely low rates have prompted traders to borrow in yen and invest in markets offering higher yields (the so-called carry trade), which has kept global borrowing costs low and facilitated rallies in risk assets.

Thus, a transition toward stricter policy in Tokyo could reverse these flows, creating ripples throughout the markets and potentially exacerbating the crypto bear market. The BoJ has already increased its interest rate to 0.75% from -0.1% over the last two years while simultaneously concluding its extensive asset purchase program. However, rates in Japan remain significantly lower than the 3.5% observed in the U.S.

The bank, therefore, has considerable room to raise rates if the situation regarding the Iran crisis deteriorates, potentially leading to increased energy costs and imported inflation in Japan and other oil-reliant nations.

Challenges ahead

However, increasing rates presents a formidable challenge given Japan’s strained fiscal circumstances. The country’s debt-to-GDP ratio stands at an alarming 240%, which means that elevated rates could sharply raise borrowing costs and pressure government finances.

Economists have suggested that Japan finds itself in a difficult position. If it raises rates and allows government bond yields to rise, it could jeopardize Japan’s debt sustainability. Conversely, if it maintains low rates, the yen will likely depreciate significantly, heightening inflation concerns.

Tensions are already visible in the foreign exchange market. The Japanese yen continues to weaken and currently hovers around 160 per U.S. dollar, marking its weakest level since mid-2024. The JPY has depreciated by 54% since 2021.