What is the yen carry trade?

The yen carry trade is a leveraged currency strategy in which investors borrow Japanese yen at Japan's ultra-low interest rates, convert the yen into a higher-yielding currency (like the US dollar, Australian dollar, or Mexican peso), and invest in assets denominated in that currency. The profit comes from the interest rate differential between the low borrowing cost in yen and the higher return on the invested assets. With the Bank of Japan maintaining rates near zero for decades while other central banks raised rates to 4-5%, the carry earned has been substantial.

The yen carry trade is estimated to represent hundreds of billions of dollars in aggregate positioning across hedge funds, banks, corporate treasuries, and retail investors (Japanese retail FX traders, known as "Mrs. Watanabe," have been notable participants). The trade works beautifully in calm markets when the yen is stable or depreciating, as the investor earns both the interest rate differential and currency gains. The yen weakened from 103 to 150 per dollar between 2021 and 2024, generating enormous returns for carry traders.

The risk is an abrupt yen appreciation. When the yen strengthens, carry traders face losses on the currency position that can overwhelm the interest income. Rapid yen appreciation triggers stop-losses and margin calls, forcing carry traders to buy yen to close positions, which pushes the yen even higher, forcing more unwinds in a self-reinforcing spiral. The July-August 2024 episode, when the yen surged from 161 to 142 per dollar in weeks, demonstrated this dynamic: the carry trade unwind triggered a global equity selloff, with the Japanese Nikkei index falling over 12% in a single day.

For global market participants, the yen carry trade is a source of systemic risk because its unwind creates cross-asset volatility. Carry traders typically invest their proceeds in equities, credit, and emerging market debt. When they unwind, they sell these assets to buy yen, transmitting stress from FX markets to equities and credit markets worldwide. Monitoring yen positioning (through CFTC Commitment of Traders data) and the speed of yen appreciation provides an early warning of potential carry trade unwinds that could destabilize global markets.