The Yen Carry Trade: Funding Bubbles and the Next Crisis

The yen carry trade has quietly shaped global markets for more than three decades, acting as a hidden pipeline that funnels cheap Japanese credit into every major asset bubble of the modern era. Stocks, bonds, real estate, venture capital, crypto – none of these markets have been immune to the gravitational pull of Japan’s near-zero interest rates.

The carry trade became a kind of shadow monetary system, silently expanding liquidity far beyond what any central bank openly admitted to creating.

The mechanism is simple: borrow cheap yen, convert it, and buy higher-yielding foreign assets. But simplicity is deceptive. At scale, this becomes a structural force; one that props up the U.S. Treasury market, inflates tech valuations, and props up risk assets across the world.

When conditions remain stable, it appears benign. When volatility rises, it becomes a loaded gun pointed at the global financial system. The world has grown addicted to the cheap funding that Japan’s central bank supplied for decades, and like all addictions, withdrawal eventually becomes unavoidable.

Now, after years of relentless yen depreciation, rising Japanese yields, and shifting U.S. interest-rate dynamics, the foundations of the yen carry trade are beginning to wobble. Its unwinding, and the violent chain reactions that follow, could mark the moment when a long-delayed global reckoning finally arrives.

How the yen carry trade works

At its heart the yen carry trade is arithmetic plus faith. An investor or institution borrows Japanese yen (historically available at near-zero or negative interest) converts those yen into U.S. dollars, and buys dollar assets that pay higher yields. The profit comes from the interest-rate spread i.e.; you pay almost nothing on the yen loan but you collect yield elsewhere.

If the exchange rate cooperates (if the yen drifts weaker versus the dollar while your investment pays out) you get an extra currency gain. In the halcyon years of 2022–24, when U.S. short-term yields approached 4–5% and the yen languished, the math turned into what many market participants seemed to treat as “free money.”

That arithmetic is fragile because it depends on two fragile things; the interest-rate gap and the exchange rate. If Japan raises rates or the yen suddenly strengthens, the trade can flip from a steady carry to a fast, margin-call-fueled exit. If the funding cost rises, or the asset you bought falls in value, the trade can blow up. When enough traders act in unison, the price moves that they themselves create, amplify the damage.

Why Japan became the plumbing of global leverage

Japan’s monetary history since the 1990s made the yen a convenient funding currency. Decades of stagnation, deflationary pressure and aggressive central-bank intervention produced a long stretch of ultra-low rates and, from 2016, explicit yield-curve control (YCC) to lock down 10-year JGB yields near zero.

That policy created a stable, super-cheap source of finance for anyone able to access Japanese markets, but within Japan in created a classic liquidity trap. Combined with deep, sophisticated financial institutions, it made yen borrowing safe enough, by market standards, to be used at scale. Meanwhile Japan’s public debt (among the highest by GDP in the developed world) meant authorities had every incentive to keep rates suppressed to avoid a fiscal calamity.

The trade’s popularity was also a product of the global interest-rate environment. When the U.S. tightened aggressively to combat inflation while Japan remained loose, the spread was enormous and irresistible. Many professional market players and hedge funds effectively turned the yen into a cheap printing press – borrow, buy Treasuries or yield instruments, rinse, repeat.

Because the assets purchased were often considered “safe” (U.S. government debt, large-cap stocks, real estate) the flow looked like a virtuous loop where capital chased returns, asset prices rose, leverage looked safer, and more capital joined the party.

The recent boom and why it mattered

During the period when U.S. yields peaked and the yen remained weak, the scale of yen-funded flows was large enough to become macro-relevant. Analysts at major houses estimated hundreds of billions of dollars in yen-funded carry positions at their height; UBS, for example, suggested an unwind of an estimated $500bn carry exposure was only halfway done during 2024 turmoil. Other estimates have put the yen carry trade in the tens of trillions, so there is considerable variation in estimates of the size of the trade. Whatever its true size is, it’s big, likely in the region of several trillion dollars.

Put bluntly; until recently, the carry trade amplified liquidity and leverage across assets. It boosted demand for U.S. Treasuries and dollar assets, helped keep long-duration bets attractive, and indirectly reduced the volatility premium on risk assets. When the plumbing worked, it helped mask structural imbalances; when it betrays investors, the same plumbing drains the bathtub fast.

What breaks the carry trade — the triggers for an unwind

There are three proximate dangers that turn a profitable yen carry trade into a loss machine.

• The first is monetary policy convergence. if Japan lifts rates or tightens yield-curve control while the U.S. cuts, the interest differential evaporates or even reverses.
• The second is currency appreciation; if the yen strengthens, borrowers face higher yen costs to repay fixed-yen liabilities they funded in dollars.
• The third is a liquidity shock; when markets fear a wider sell-off, funding lines dry, margin calls accelerate, and positions that looked safe are forcibly closed.

All three threats became visible in recent years. The Bank of Japan has begun to tinker with YCC and reduce its market support, signaling a move away from the radical stimulus that sustained decades of near-zero JGB yields. That adjusts both market psychology and the technical conditions for carry trades.

At the same time, episodes of global dollar strength or volatility (whether in 2020, 2022, or market jolts since) have historically been moments when yen carry positions are unwound violently, causing the dollar to fall sharply, U.S. stocks to fall, and rising yields on U.S. Treasuries.

What a Carry-Trade Unwind Means for the Dollar, Inflation, and the Repo Market

If the yen carry trade begins to unwind in earnest, two things happen immediately and mechanically: the dollar weakens and Treasuries get sold. These aren’t predictions; they’re the basic plumbing of closing the trade.

Here’s the chain reaction in plain language.

Why the Dollar Falls

Unwinding the trade requires investors to sell the dollar assets they originally bought, convert the proceeds back into yen, and repay their yen loans. That process forces dollar selling and yen buying whether investors like it or not. If enough people unwind at once, the dollar can fall quickly.

A weaker dollar then filters into the real economy. Imports become more expensive, global commodities priced in dollars tend to rise, and the cost of foreign goods and inputs increases. In short, a falling dollar adds upward pressure to U.S. inflation even as risk assets may be falling at the same time. That mix of currency-driven inflation and asset-driven deflation is part of what makes an unwind so destabilizing.

Why the Repo Market Gets Dragged In

Most yen-funded investors don’t simply hold Treasuries; they borrow against them in the U.S. repo market to boost their returns. Treasuries are the core collateral of the financial system, so when they are sold during an unwind, their prices fall. As prices fall, their collateral value declines, and repo lenders demand more margin or insist on stricter terms. This puts pressure on leveraged investors, who may be forced to sell even more assets to meet those demands.

As selling intensifies, collateral values drop further, more margin calls emerge, and liquidity tightens. Repo rates can rise sharply as borrowers scramble to secure short-term cash and lenders become more cautious. What began as a currency unwind in Japan thus morphs into a tightening of U.S. dollar funding conditions. Stress in the repo market doesn’t stay contained; it ripples across banks, hedge funds, and any institution relying on collateralized financing.

The Bottom Line

A large carry-trade unwind weakens the dollar, nudges U.S. inflation higher, and strains the dollar’s own funding infrastructure. Once leverage and collateral dynamics come into play, the unwind becomes far more than a currency event – it becomes a stress test for the global financial system.

When will the yen carry trade unwind?

Timing the unwind is impossible to do with precision, but the outlines are clear. The carry trade is most vulnerable at inflection points in central-bank policy and during global risk-off episodes.

We are in such an inflection now; the Bank of Japan has signaled the end of some ultra-loose practices and started moving the policy regime, while markets increasingly price a future where the yen is less persistently weak. If U.S. policy slips into easing while Japan normalizes, the differential that funded the trade will shrink. That reduces the incentive to borrow yen and increases the risk of snapbacks.

An unwind doesn’t need a single dramatic event; it unfolds in stages. First, as spreads compress, marginal carry-traders stop adding positions. Next, any shock (a sudden rise in U.S. real yields, a crisis in a major bank, or a geopolitical shock) can provoke a wave of repatriation i.e., yen buys and dollar sells.

Prices move quickly when positions are crowded. Global equities and real estate that were indirectly supported by cheap yen funding would be among the first to suffer, followed by sovereign bonds as liquidity stresses cascade.

The story that many investors prefer not to tell is structural; if much of the liquidity supporting U.S. Treasuries, corporate credit and property is tied up with cross-currency funding, large reversals put both price and financing stress on those markets simultaneously.

Why the unwind could be systemic

This is where a historian of credit cycles would sit up and take notes. The post-1971 era (when the dollar’s gold convertibility ended and global finance took a modern, fiat turn) has been a century’s worth of successive credit expansions without the old anchor of gold. Central banks now conspire, implicitly and explicitly, to keep rates low for political and fiscal convenience.

That is a fertile field for mispriced risk and carry strategies. The yen carry trade is only the most visible example of a funding-based distortion that pushes capital into yield-sensitive assets across borders.

If the carry trade unwinds rapidly, two broad mechanisms will transmit the shock.

• Balance-sheet pain: leveraged funds and institutions that borrowed in yen will suffer losses and face margin calls.
• Market-structure: even unleveraged holders of U.S. Treasuries, equities, or real estate will see prices fall as liquidity evaporates and risk premia reprice.

Given the scale of global debt and the proliferation of strategies dependent on cheap funding, the unwind could nourish a broader credit contraction that makes 2008 look like a preview of the recession to come. For anyone who has tracked decades of credit cycles, this is not hyperbole; it is the natural consequence of systemic leverage meeting policy reality.

FAQs

Conclusion: not a prediction, but a prognosis

The yen carry trade began as a rational exploitation of policy asymmetries. It matured into a structural plumbing system that lubricated yield-seeking behavior across markets. Now that the Bank of Japan is nudging the plumbing into a different configuration, investors should treat the carry trade as an unresolved moral hazard whose correction is overdue.

When the unwind accelerates, it will not be merely a currency story; it will be a stress test for every market that depended on cheap, cross-border funding – U.S. Treasuries, equity valuations, and real estate among them.

If you prefer comforting narratives i.e., that central banks can orchestrate soft landings forever, and that markets will gradually absorb every policy shift, you will find reasons to ignore this. If you prefer to learn from history, the lesson is that policies which create cheap funding and encourage speculative flows always leave a bill.

The yen carry trade is one of the largest tabs outstanding. When it is presented to the global economy, the sting will be felt far beyond Tokyo or the currency desks. The prudent course is to prepare for a world where cheap leverage is less cheap, volatility is higher, and asset prices have to find new, sustainable anchors.

The unwind won’t announce itself in polite terms; it will arrive in the language of margin calls and credit spreads.

Related Pages:

• Floating vs Fixed Exchange Rates – Explains how yen-dollar movements affect the trade.
• Imported Inflation – Relevant when a weaker dollar raises import prices in the U.S.
• Fisher Equation – Links interest rates, inflation expectations, and currency valuation.
• Debt Deflation Theory – Highlights systemic risks if asset bubbles unwind.
• Business Cycle – The carry trade amplifies and interacts with cycles of boom and bust.

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