Betting on the yen: the risks of the carry trade
As the country’s central bank tightens monetary policy, investors who leveraged its currency for higher yields may be forced into a sell-off
Leo Lewis and David Keohane in Tokyo
© Philip Fong/AFP/Getty ImagesIn early September, the top foreign exchange experts at Japan’s biggest banks started taking calls from investors and regulators with two big questions: how big is the yen carry trade, and how close is it to unwinding?
The short answers from the Tokyo forex gurus — “nobody exactly knows” and “a lot closer than we would like” — were of little comfort to them.
The yen carry trade is the term for when hedge funds and others use Japan’s currency to access low-cost financing to make bets in markets across the world.
For almost 30 years, investors have borrowed the cheap, stable yen in order to fund higher-yielding investments elsewhere, exploiting differences in interest rates and, in particular, the fact that until this month the central bank benchmark rate had not risen above 1 per cent since 1995.
But every so often, those differences threaten to shrink, or the value of the yen shifts with unexpected speed.
Investors exit carry trades and dump the acquired assets — fuelling spectacular spasms in global markets from emerging economy debt and Nasdaq stocks to cryptocurrencies and luxury property.
For this reason, the health of the global economy is deeply connected to the state of the yen, making the carry trade a proxy — albeit an opaque one — for risk.
“The yen carry trade is one of the main potential sources of market instability,” says Masayuki Nakajima, a senior strategist at Mizuho Bank, reflecting the concerns of foreign regulators.
The most recent major ruction in the carry trade was in 2024, immediately after the Bank of Japan raised interest rates definitively above zero for the first time in well over a decade.
It helped send global markets into a tailspin.
This time around, the damage could be much further reaching.
Even though its true size is extremely hard to gauge, the current value of the carry trade may far exceed $2tn, making it probably the biggest it has ever been, the world’s regulators heard from the experts in Tokyo.
The concern that the cheap yen may be anchoring US Treasuries and may have helped inflate a bubble in AI-related shares, they added, leads the list of worries.
Many strategists now say that one of the top risks for the year is the danger that the carry trade unwinds.
Of investors and regulators who have been in touch in recent weeks with numerous analysts, Nakajima says: “Their main focus is very clear, whether an unwinding of the yen carry trade could lead to a global sell-off.”
And while an unwind, unruly or otherwise, is not the base case of most analysts, many see it as a far more pressing threat than it was as little as six weeks ago.
US Treasury secretary Scott Bessent warned last month that “disorderly yen markets can trigger forced unwinds, which could destabilise global markets”, setting out his justification for a historic joint Japan-US intervention to support the yen at the end of July.
The intervention helped to stabilise the currency, which had hit a 40-year low with short-term traders heavily positioned against it.
But some now worry that further interventions and hawkish pressure from the US on the BoJ to accelerate its rate increases — which may continue, even after Japan raised rates to 1.25 per cent on Friday — could lay the conditions for the very unwind that policymakers are trying to avoid.
Mizuho’s Nakajima and others say there is more to the unwinding risk than the market has yet appreciated.
The image that investors and regulators may have had about the trade, about who was using it and about how it has been inflated over recent years, was incomplete.
The yen carry trade in 2026, say Nakajima and others, should be considered in much broader terms: it is fuelling not just leverage but also real economic strategy.
Once, it had indeed been the preserve of fast-moving speculators.
A version of the trade had also long been a favourite of “Mrs Watanabe”, a shorthand for Japanese retail investors whose response to ultra-low interest rates at home has been to swap their yen savings for riskier but more lucrative investments abroad.
But they have been joined by the mammoth of corporate Japan: hundreds of major companies that have staked their future outside the shrinking home market and are funding a $2tn transformation, much of it with cheap yen.
“Japan is by far the biggest source of foreign direct investment into the US.
So if those flows reversed, it would probably have a significant effect on global markets as well as the global economy,” says Nakajima.
That dynamic, and Japan’s newly “normalised” monetary conditions after decades of abnormality, is in the process of fundamentally changing the yen carry calculus.
The yen carry trade has long tracked and fuelled the megatrends in global markets, say investors.
Now a new era may be dawning.
The yen carry trade is perfect until it isn’t, say some investors.
Borrowing at reliably low rates in one place and investing at reliably higher rates of return elsewhere is global finance 101.
But it requires careful attention.
It is vulnerable to currency volatility, to government intervention and to sudden market fears of a change in central bank policy direction.
For much of the past couple of decades, Japan has provided a sweet spot.
The carry trade does not normally appear to worry financial regulators or major institutions until its fragility is laid bare.
In the most striking cases, the build-up for an outright collapse has been rumours about central bank moves and a single, data-driven trigger.
Conditions, say traders in Tokyo, London and New York, that seem applicable now.
When the carry trade has unwound, it has left collateral damage.
It was a key factor in the crash that took down hedge fund Long Term Capital Management in 1998.
It was a pivotal factor in the “quant meltdown” in 2007, which many see as the precursor to the global financial crisis a year later.
But in the summer of 2024, in an incident that has since been minutely studied by the Bank for International Settlements for its global impact and the potential lessons for regulators, the fragility of the carry trade became especially clear.
The first half of July that year saw a long phase of yen weakness begin to reverse, as the market traded on rumours of potential interventions by the Japanese authorities.
That altered the incentives for many leveraged speculators, the BIS later said in its report.
Turbulence in markets became noticeable.
By July 24, after months of rallying, AI and technology stocks crashed, in a rout that wiped billions from the market.
The yen surged, creating the perfect conditions for a sudden unwind of the carry trade.
The ultimate triggers were a hawkish-sounding rate increase by the BoJ and a relatively minor, somewhat disappointing data point from the US labour market.
“The [US labour market] news could hardly be taken as an unequivocal sign of a deteriorating outlook, let alone a looming recession,” said the BIS report.
“Yet, markets had become hypersensitive to any signs of a change in growth momentum and in the associated monetary policy outlook.”
What followed is precisely what regulators and investors now fear: massive unwinding of leveraged positions and carry trades, rippling out through global markets.
The broad Topix index of Japanese stocks lost 12 per cent in a single session.
US, European and Asian markets plunged.
Bitcoin, as an indicator of the yen carry trade’s infiltration into all corners of global risk trading, fell 16 per cent over a few days’ trading.
The Mexican peso, along with other emerging market currencies that have long been a destination for yen-funded bets, lurched violently as those bets were removed.
By the end of the week, some of those markets had recovered: the fear this time is that the rebound may be more elusive.
So how extensively has the speculative, leverage-seeking side of the carry trade been reinflated since 2024 and how precarious is it now?
The size of the carry trade remains notoriously difficult to measure.
Hedge funds often trade with off-balance-sheet derivatives which can stay mostly hidden from the eyes of regulators, while yen borrowing can be visible without it being clear where that money is being put to work.
According to US Commodity Futures Trading Commission data, which gives only a limited view into the market, short positions on the yen surged in 2021, both outright and as a share of overall positions, before unwinding in late 2024 and early 2025.
They were rebuilt in 2026 and only began to unwind again over the past fortnight.
“The low in dollar-yen volatility . . . tends to suggest we’re in the early stages of an unwind,” says Kit Juckes at Société Générale.
Shrikant Kale, a quants analyst at Jefferies, estimates that outstanding cross-border yen borrowing — from hedge funds but also the likes of banks, corporates and households — increased by 67 per cent to ¥360tn ($2.3tn) between December 2021 and March 2026.
That surge, Kale said in a recent note, suggests a substantial build-up in yen-funded leverage and means that “the current cycle is by far the largest carry-trade build-up of the past three decades, highlighting the potential vulnerability of global markets to a disorderly unwind”.
The only two comparable historical moments, adds Kale, took place between 2003 and 2007 and between 1995 and 1997 — both periods that ended with sharp, painful carry trade unwinds.
What is different this time is the part that corporate Japan is playing.
In previous reckonings of the carry trade, the overseas investments of Japanese companies were rarely considered.
But because the companies have long been able to rely simultaneously upon an ultra-low cost of funding in yen and a consistently strong US dollar, they have had no reason to hedge their overseas investments, which have built to unprecedented levels.
According to data from Citi, the total outstanding Japanese stock of foreign direct investment, incorporating equity capital, reinvested earnings and debt capital, reached ¥384tn in 2025, meaning it has increased from 20 per cent of GDP in 2014 to more than half today.
Citi estimates that non-financial corporations in Japan now hold more overseas assets than banks, pension funds and insurance companies.
“This is structurally a type of [yen carry] position, and the building of the position puts downward pressure on the yen,” says Citi’s chief FX analyst Osamu Takashima.
The yen carry trade holds the potential for global trouble in the short and long term, analysts say.
In the short term, the risks are clear.
First, that this summer’s $96bn intervention by the US and Japan in the dollar-yen rate could be a turning point for the yen.
And second, that the BoJ could raise rates even faster than the market is expecting, strengthening the currency far beyond the current level of around ¥157 to the dollar and undermining the logic of the speculative carry trade.
The longer-term risks are more nuanced, but once set in motion, say analysts, could be much more profound.
Japan is emerging from decades of deflation and the BoJ is normalising its policy after years of fuelling the belief that the yen could permanently be used to fund risk at a knockdown price.
Japan’s current policy rate of 1.25 per cent, and headline inflation of 1.7 per cent, may seem low by global standards, but the sense of divorce from years of expectation, say traders, is palpable every day.
This normalisation of monetary policy means that rates are likely to keep rising for at least a while longer, increasing the attractiveness of Japanese assets to the masses of companies and financial institutions that have bought into dollar assets in search of yield.
For years, the speculative carry trade and the enormous underlying outflow of corporate Japan’s investment created downward pressure on the yen.
Now, analysts are wrestling with the prospect of that being reversed - even if many believe that Japanese households and companies are too conservative to move with speed.
The mere fear of such an outcome could start a carry trade unwind in motion as investors rethink how safe their current positions really are.
“Once doubts arise about their dollar positions abroad,” says Citi’s Takashima, “hedging transactions and repatriation [of capital] this time could be unprecedentedly severe.”
A new factor in assessing the risk of a carry trade unwind, say analysts, is the intense interest that Bessent has shown in the level of the yen, in BoJ policy and Japan’s Prime Minister Sanae Takaichi’s attempts to reinflate the domestic economy.
High on Bessent’s apparent list of fears is that the carry trade has been, over a now protracted period of years, a huge contributor to holding down yields on US government debt as lower-risk players of the strategy bought US Treasuries.
A sharp carry-trade reversal, or a massive but gradual repatriation of Japanese capital taking advantage of decades-high yields on domestic bonds, could prove extremely painful to Bessent and other finance ministers across the world.
During its era of rock-bottom yields at home, Japan has been a reliable source of demand to absorb record levels of rich-world sovereign borrowing.
Some analysts viewed the US motivation behind its yen buying in July as a desire to help stem a combined currency and bond slide that could prompt Japan to sell its Treasury holdings, or for domestic investors to bring money home.
Bessent upped the stakes earlier this month, warning speculative investors not to bet against the yen, saying “I am the house now”, and adding that he had a “pretty good insight into what the Bank of Japan is going to do”.
Some believe that the normalisation in Japanese interest rates will erode the yen’s longtime role as the funding currency for the world’s trades.
Another popular funding currency, the Swiss franc, has tumbled in recent months as the Swiss National Bank has kept interest rates rooted at zero while other big central banks hike rates.
As Barry Eichengreen, professor of economics and political science at the University of California Berkeley, puts it, the yen’s “funding currency days are over now that Japanese interest rates are finally beginning to normalise”.
But plenty will make the opposite case.
The Japanese economy is still beset by myriad weaknesses, most strikingly demographics, that argue against fast interest rate rises.
It is probable that a significant gap will remain between interest rates in Japan and the US.
Last week, the US Fed raised rates for the first time since 2023, to 3.75-4 per cent, and signalled that it was prepared to take further steps to curb inflation.
The fragility in sentiment was evident as the yen tumbled even after the BoJ raised rates on Friday, and signalled more rises to come.
Investors spoke of a “rate hike race” as the two central banks tighten policy.
As Bessent’s comments and the joint intervention fade from memory, the fundamentals of the carry trade will remain, say some analysts.
“I just found it odd that people came out [after the yen strengthened following the intervention] saying the yen carry trade was dead,” says Shoki Omori, chief rates strategist at Deutsche Bank in Tokyo.
“It’s not going to be easy to change the structure of the market.”
Additional reporting by Ian Smith
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