For years, Japan provided some of the cheapest money in the world. Investors could borrow yen at rates close to zero, convert the money into dollars and invest in higher yielding US assets. When Japanese rates were around 0% and US rates were above 5%, the economics were hard to ignore.
That gap is now shrinking. The Bank of Japan has moved rates higher, while US rates have come down from their peak. The carry remains positive, but investors are earning considerably less for taking the same currency risk. If Japanese rates continue rising while the Federal Reserve cuts further, the spread could narrow even more.
Currency risk is what makes this particularly important. Suppose USDJPY is at 160 and an investor borrows ¥1.6 billion, converts it into roughly $10 million and earns a 3% annual carry. That is about $300,000. But if USDJPY moves from 160 to 150, the yen has strengthened by more than 6%. The currency move can easily overwhelm the income generated by the trade.
The equation becomes even more interesting when governments get involved. The US has joined Japan in supporting the yen through coordinated currency intervention. For investors accustomed to treating yen weakness as a relatively safe part of the carry trade, US participation changes the risk calculation. A stronger yen is particularly dangerous when positions are leveraged.
This can also become self reinforcing. When the yen rises, investors may start closing carry trades. To unwind them, they sell foreign assets and buy yen to repay their borrowing. That buying pushes the yen higher, putting pressure on other leveraged positions and potentially forcing further unwinding.
We saw how quickly this mechanism can matter during the market volatility of 2024. The yen is not simply another currency. It has been a major source of cheap funding for positions across global equities, bonds, credit and currencies.
The yen carry trade is not dead. There is still a meaningful interest rate advantage to investing outside Japan. But the margin of safety is shrinking. Japanese rates are rising, US rates have moved lower, and Washington has shown that it is willing to help Japan support the yen.
For years, investors were paid handsomely to bet against the yen. Now they are being paid less while the currency risk remains substantial.
If that trend continues, the story will become much bigger than USDJPY. One of the world’s most important sources of cheap liquidity will be getting more expensive, and global markets may eventually have to adjust.