From rising Japanese bond yields to global liquidity contraction to the Bitcoin crash

I. Rising Carry Trade Costs Lead to Yen Exchange Rate Fluctuations

As mentioned yesterday, since November 10th, as Japanese government bond yields have risen, foreign exchange market investors have intensified their selling of yen, leading to a rapid depreciation of the yen against the dollar. This is because people are not optimistic about the soundness of Japan's fiscal situation. Another reason is the rising cost of carry trades.

0, and use the money to buy US Treasury bonds (or other countries' bonds, stocks, etc.). After one year, you receive the principal and interest, which are then converted back into yen at the exchange rate E1 to repay the principal and interest. The yield of this simple carry trade is: However, now that Japanese interest rates have risen, the cost of the carry trade has also increased, and the yield has decreased. For example, in the above formula, if the exchange rate remains unchanged, and the interest rate on borrowing in Japan rises from 0.5% to 2%, the yield of the carry trade will decrease from 3.5% to 2%. If exchange costs are taken into account, the yield will decrease even more. This leads to increased volatility in the yen/dollar exchange rate as Japanese government bond yields rise. Market participants seek profit opportunities amidst these fluctuations until they can no longer profit. Some investors will abandon carry trades. II. Global Liquidity Contraction? Over the past two or three decades, the Bank of Japan has continuously implemented quantitative easing (QE), expanding the monetary policy and releasing massive amounts of liquidity. Unable to find good profit opportunities in Japan, these funds flowed out of Japan and into international financial markets, making the yen a major global funding currency. Carry trades are simply the simplest form of Japan exporting capital to international markets. Many have obtained low-interest financing from Japan and then invested it in foreign stock markets, commodity markets, and cryptocurrencies. Now, with the rise in Japanese government bond yields, the financing costs for international investment institutions that previously relied on low-interest loans from Japan will increase, which will have several effects: [1] They are forced to change their investment strategies, sell some assets, reduce some high-risk investments (such as reducing leverage ratios, reducing investments in stock markets, commodity markets, and cryptocurrencies), and repay loans from Japan. This will undoubtedly lead to a decline in the prices of related assets and trigger a chain reaction. The sharp decline in the US stock market, Hong Kong stock market, A-share market, and cryptocurrency market in recent days is related to this. Figure 2 Bitcoin Price (Unit: USD) [2] They will reduce their borrowing from Japan. This means that the activity level of international financial markets will be affected to some extent in the future. However, the magnitude of the impact cannot be measured. [3] It may affect the balance sheets of some financial institutions, households, enterprises, and governments if they previously relied on low-interest financing from Japan. However, the extent of this impact cannot be measured. [4] As I mentioned yesterday, Shanaka Anslem Perera's article argues that funds raised from Japan and then invested in the US and European government bond markets will decrease, leading to... In short, the rise in Japanese government bond yields is something to pay attention to and be wary of, but there's no need to panic excessively.