What Is the Yen Carry Trade? Why a Stronger Yen Could Shake Global Markets

The yen carry trade is back in focus as the Japanese currency strengthens sharply and investors reassess expectations for Bank of Japan interest-rate increases. With the yen trading near a seven-month high against the US dollar, markets are watching whether the long-running strategy of borrowing cheaply in yen and investing in higher-yielding assets could face another major unwind.

The yen has traditionally been one of the world’s preferred funding currencies because Japanese interest rates remained very low for an extended period. Investors could borrow yen at relatively low costs and use the proceeds to buy higher-yielding currencies, bonds and other assets.

How Does the Yen Carry Trade Work?

The basic strategy is straightforward. An investor borrows Japanese yen and converts it into another currency offering a higher interest rate. The money can then be invested in assets such as US dollar-denominated bonds, emerging-market currencies or other higher-yielding instruments.

The investor earns the difference between the borrowing cost and the return on the investment, assuming exchange rates remain favourable.

Reuters estimates that annualised returns on dollar-yen carry trades have typically been around 2.5% to 3.5%, although returns were considerably higher during 2024.

The strategy becomes more attractive when the yen remains weak. However, a rapid rise in the Japanese currency can reverse those gains because investors must eventually convert their holdings back into yen to repay their borrowing.

Why Is the Yen Carry Trade Under Pressure?

The current risk comes from a combination of stronger yen momentum and expectations for faster Bank of Japan tightening.

The yen has gained roughly 4% over five sessions and recently reached a level around 152.89 per dollar, its strongest point in about seven months. Traders have been reducing bearish yen positions as expectations increase for a BOJ rate hike as soon as next week.

This matters because higher Japanese interest rates reduce the attraction of borrowing yen. At the same time, a stronger yen can increase the cost of maintaining existing carry positions.

How Large Is the Trade?

The exact size of the global yen carry trade is difficult to measure because positions are spread across banks, hedge funds and other investors.

Reuters cited Jefferies analysis of Bank for International Settlements data showing cross-border yen borrowing reached a record 360 trillion yen, equivalent to about $2.34 trillion, in March. Speculative positioning also remains important, with traders holding significant yen short positions.

Leverage can make the actual market exposure larger than the headline borrowing figures suggest. If the yen rises rapidly, leveraged investors may be forced to close positions, potentially creating additional demand for the Japanese currency.

Could Another Carry Trade Unwind Hit Global Markets?

The biggest concern for investors is that a sudden yen rally could trigger forced selling across other asset classes.

A similar episode occurred in July 2024 when an unexpected BOJ rate increase contributed to a sharp yen rally. Carry traders rushed to unwind positions, while global equities came under significant pressure. Japan’s Nikkei recorded a particularly severe one-day decline during that episode.

The current situation is different because BOJ officials have been signalling the possibility of further tightening. Markets therefore have more time to adjust, and the yen’s recent move has so far remained relatively orderly.

What Forex Traders Should Watch

For forex traders, USD/JPY is the most direct indicator of carry-trade pressure. A sustained break lower in USD/JPY would indicate further yen strength and could increase pressure on yen-funded positions.

Traders should also monitor Japanese interest-rate expectations, government bond yields, speculative positioning and global equity performance.

The broader market question is whether the yen’s appreciation remains a controlled adjustment or develops into a wider carry-trade unwind. If the BOJ delivers a rate increase and signals that more tightening may follow, the yen could remain supported.

For now, there is no clear evidence of a repeat of the 2024 market shock. However, with yen short positions still significant and global investors heavily exposed to interest-rate differentials, the carry trade remains an important risk to watch.

A stronger yen is not just a currency story. It can influence bonds, equities, commodities and risk sentiment across global markets.