The yen carry trade is a strategy in which investors borrow Japanese yen at very low interest rates and invest the proceeds in higher-yielding assets elsewhere, such as US Treasuries, Mexican government bonds or American technology shares. The profit comes from the gap between cheap yen funding costs and higher returns abroad. The risk comes from the exchange rate: if the yen strengthens sharply, the cost of repaying the borrowed yen rises and the trade unwinds, often violently.
How the trade works
For most of the past three decades the Bank of Japan held interest rates at or near zero while other central banks paid meaningfully more. A fund could borrow yen at close to nothing, convert it into dollars, and earn 5 per cent or more in US money markets or far higher in risk assets. As long as the yen stayed weak or stable, the spread was close to free money, and the persistent selling of yen to fund the trade itself kept the currency weak. That self-reinforcing quality is why the position grew so large: estimates of yen-funded positions ahead of the 2024 unwind ran from hundreds of billions to over a trillion dollars.
Why it unwinds violently
The carry trade embeds leverage and a crowded, one-way position. When the yen strengthens, losses on the currency leg force some funds to close positions, which means buying back yen, which strengthens the yen further and forces the next tier of funds out. The exit is reflexive: the act of leaving makes leaving more expensive for everyone else. Because the borrowed yen funded positions in equities, credit and emerging markets, forced unwinds transmit Japanese currency moves into global risk assets within hours.
August 5, 2024: the case study
The clearest modern example came in the summer of 2024. The Bank of Japan raised rates on 31 July, the yen jumped, and within three trading sessions Japan’s Topix fell over 12 per cent in a day, the VIX spiked to 65 and US equities sold off sharply, despite no fundamental change in American corporate earnings. The episode demonstrated how a funding currency shock becomes a global volatility event. Khan Capital’s full analysis of that episode is linked below.
What to watch
The ingredients for future unwinds remain: the Bank of Japan’s policy rate relative to the Federal Reserve’s, the size of speculative short-yen positioning in CFTC data, and the level of USD/JPY relative to interest-rate differentials. When the yen weakens well beyond what rate gaps justify, carry positioning is usually the reason, and the snap-back risk builds.