Yen Carry Trade

How the world's cheapest money funded global risk for years—and why this scheme no longer looks immortal

The yen carry trade is one of the most important, yet least noticeable, structures in global markets. Its logic is simple: an investor borrows funds in Japanese yen, where the cost of financing has historically been very low, converts them into another currency, and buys higher-yielding assets—from government bonds and corporate credit to emerging market currencies and stocks. As long as the interest rate differential is large, volatility is contained, and the yen does not strengthen sharply, this strategy works almost like a mechanical generator of returns.

The key to this model is not just low interest rates in Japan, but an entire multi-year architecture of Japanese monetary policy. Decades of ultra-loose conditions have made the yen a natural source of cheap funding for global investors. As long as the Federal Reserve and other central banks keep rates significantly higher, the spread in favor of the carry trade remains sufficient to compensate for currency risk. This interest rate differential explains why the yen carry trade was not a marginal speculation, but one of the fundamental pillars of global risk-taking.

However, like any carry trade, it has a fundamental weakness: it works well gradually and collapses abruptly. As long as the funding currency weakens or at least does not strengthen, the investor earns a spread. However, when the yen begins to rise sharply, the entire structure is overturned. The debt borrowed in yen becomes more expensive in recalculation, profitability shrinks, and participants simultaneously close positions. This is why an unwind of the yen carry trade is often accompanied by a sharp increase in volatility in global markets.

Therefore, the main question for the market is not "does carry trade exist?", but "how stable are the conditions that allow it to exist?". In 2025–2026, this stability became significantly less obvious. On the one hand, the Bank of Japan no longer looks like a guarantor of perpetually zero rates. On the other hand, even a moderate rate hike in itself does not destroy the carry trade; the pace of change and the movement of the yen itself are more critical.

Current state

At present, the yen carry trade has not disappeared, but it no longer looks as one-sided as before. Some strategies remain stable, especially where investors use currency risk hedging. At the same time, the market shows signs of tension: sensitivity to USD/JPY movements is increasing, attention to the Bank of Japan's policy is intensifying, and potential interventions are once again becoming a factor.

This state can be described as unstable equilibrium — the structure still works, but its foundation has already begun to shift.

The first key factor is interest rates. The Bank of Japan has already moved away from its zero interest rate policy, and the level of about 0.75% is the highest in decades. Compared to rates in the US or other economies, the differential still remains significant, which supports the carry trade. However, it is not the value itself that is important, but the direction of movement: Japan is transitioning from ultra-loose policy to gradual tightening for the first time in a long time. This changes the perception of the yen as an "eternally cheap" source of funding.

The second factor is the scale of the carry trade itself. Unlike classic positions, a significant part of this strategy is implemented through derivatives, FX swaps, and leverage. Because of this, its real size cannot be accurately estimated: narrow estimates speak of hundreds of billions of dollars, while broader approaches suggest trillions. This means that the market effectively does not know what volume of positions can be closed simultaneously in the event of stress.

The third element is the behavior of the yen itself. Despite the policy change, JPY remains a weak currency due to the interest rate differential. This supports the carry trade, as investors continue to earn returns not only from the spread but also from exchange rate dynamics. But this is where the main risk lies: any sharp strengthening of the yen instantly changes the economics of positions. Historically, even relatively small currency movements can trigger a large-scale unwind.

The fourth factor is the gradual decline in the attractiveness of the carry. Rising Japanese bond yields mean that the cost of funding is no longer minimal. This compresses the net spread and forces investors to rely more on exchange rate stability, rather than just the interest rate differential. Thus, the strategy becomes more sensitive to currency risk.

Despite this, the yen carry trade continues to perform its key function—being a source of global liquidity. It supports demand for risky assets, including stocks, credit instruments, and emerging market currencies. As long as this structure works, the global market retains the ability to expand risk.

However, the risk structure has changed significantly. The main one is policy risk. The market can no longer assume that the Bank of Japan's policy will remain unchanged. Even a gradual rate hike creates uncertainty and changes investor behavior.

The second key risk is currency risk. The carry trade does not collapse due to interest rates—it collapses due to the exchange rate. A sharp strengthening of the JPY can simultaneously make most positions unprofitable, leading to a synchronous closing of positions and a shock transmission to other markets.

The third risk is leverage. A significant part of the carry trade is built on the use of leverage. This means that even relatively small market movements can lead to disproportionately large losses and forced position closures.

The fourth aspect is liquidity. The yen carry trade effectively acts as one of the hidden channels for providing global liquidity. Its reduction automatically means a decrease in the availability of funding for risky assets.

As a result, the current regime can be described not as the end of the carry trade, but as a transition to a new phase. It is no longer a stable strategy with a clear logic of returns, but a system with built-in asymmetric risk. It may continue to operate under favorable conditions, but its vulnerability to abrupt changes has significantly increased.

Practically, this means that the yen carry trade remains one of the main indicators of the global market regime. As long as it functions, markets retain a tendency towards risk-on behavior. But in the event of its disruption, the reaction extends far beyond the currency segment and affects all asset classes.