In a nutshell, the yen carry trade is when investors borrow Japanese yen at very low interest rates, convert to U.S. dollars, and then invest in U.S. Treasuries, U.S. equities, and other various U.S. assets. These investors make their returns in the United States and have traditionally made big profits with these trades. Many of these investors have magnified their profits in this trade by aggressively utilizing leverage. They can easily convert their dollars back to yen to cover their loans with minimal interest expense. For an extended period, Japan had near- zero interest rates and the Japanese yen had been in decline vs. the U.S. dollar. From 2019 to 2026, the yen has been falling against the dollar. The currency pair had surged to a four-decade high near 164 in late July 2026. In other words, it took 164 yen to buy one U.S. dollar.
Fundamentally, the yen carry trade functions as a form of global leverage. Global markets have grown unusually interconnected. One of the tightest links runs from the yen carry trade straight into the largest U.S. technology stocks. As a reminder, the S&P 500 is being propped up by the appreciation of these 10-20 U.S. technology stocks, with the yen carry trade serving as a hidden form of leverage sitting underneath the major stock indexes. A sudden reversal in the Japanese yen can pull equities lower even when nothing has changed in the companies themselves. For anyone following big tech stocks, the behavior of the yen has become impossible to ignore. A currency move that begins in Tokyo can surface hours later as a deleveraging wave across U.S. equities.
Its always been my contention that the most important data point in the world economy is the current yield for U.S. Treasury Notes with a 10-year maturity. I've recently arrived at the conclusion that coming in a distant second place at this point in time would be the exchange rate between the U.S. dollar and the Japanese yen. For the last couple of years, some investors have been concerned, if not outright fearful, that the yen carry trade could unwind in a rapid fashion and wreck havoc on the capital markets. We witnessed what the yen carry trade unwind would look like in August 2024. The Bank of Japan raised interest rates from zero to 0.25% in late July 2024. Simultaneously, weaker U.S. jobs data fueled expectations that the Federal Reserve would cut the policy rate at the next FOMC meeting. These actions combined to rally the yen 8% against the dollar (moving from 162 to 148.) The impact in the markets was immediate and profound. Rising yen costs led to margin squeezes that forced automated liquidations of global assets. U.S. and Asian equities plunged in early August 2024 - the Nikkei 225 dropped 20% and major U.S. indexes slid sharply. Fortunately, the ship righted itself by mid-August (2024) and widespread carnage was largely avoided. Although a major market disaster was avoided in August 2024, the structural features and risk inherent in this trade deserve continued attention by investors.
As we return to the present day (October 2026), it is evident that the risks associated with the yen carry trade are stirring and threatening to awaken from dormancy. It took several years, but like practically every other country, Japan is finally experiencing inflation in their economy. Their current government is seriously considering engaging in fiscal stimulus, which will only accelerate inflation. The yen has been taking its lumps. The U.S. recently intervened to push up the yen, but that attempt was only successful on a temporary basis. A more meaningful recent (9/18/26) maneuver was the Bank of Japan raising its benchmark interest rate to 1.25%. This marks the highest interest rate level in Japan since 1995, continuing a steady departure from long-standing negative and near-zero interest rates.The general prediction is that Japan will be forced to continue raising interest rates to deal with inflation and the devaluation of its currency. This could ultimately lead to the collapse of the yen carry trade. Institutions and individual investors will have to sell their assets, buy back the yen, and cover their debts before the yen's value increases too much and they lose too much money. This could lead to rapid selling of U.S. securities which of course would have significant, negative implications for the market.
Unlike spendthrift Americans, the Japanese are prodigious savers. The historic low interest rates in Japan have encouraged Japanese investors to invest overseas. For an extended time, Japan was the world's largest creditor nation. Although they now trail only China in that regard, Japan has accumulated over $6 trillion of foreign assets. In terms of Purchasing Power Parity (PPP) and historical real effective exchnage rates, all indicators suggest the yen is approximately 40% undervalued against the dollar. If Japan continues on the tightening track and interest rates and the yen move upwards, many Japanese investors will see an opportunity to repatriate their investments back to their home country.
The assumption laid out in this blog is that various factors will lead to a stronger, more valuable yen. The carry trade depends not just on Japan's rate, but on the interest rate differential with the United States. President Trump has consistently been obsessed with pushing down U.S. interest rates. This still appears to be the case even if lowering interest rates would be detrimental to the overall economy. Hopefully, the Federal Reserve Open Market Committee will retain their independence from political shenanigans and do what is best for the country and its citizens. Higher interest rates in Japan combined with lower interest rates in the U.S. would facilitate a stronger yen and weaker dollar. As mentioned earlier, this scenario would doom the yen carry trade and exert downward pressure on U.S. assets.
