What Is Yen Carry Trade? The Nervousness That’s Gripping Global Markets

Carry trade is a long-established currency-market strategy in which investors borrow low-yielding currencies to invest in higher-yielding ones. For years, thanks to the Bank of Japan’s ultra-low interest rates and a weak yen, the Japanese currency became one of the world’s favourite funding unit. But when the yen strengthens against the dollar, those trades quickly turn unprofitable, pushing investors to unwind positions, often triggering broad sell-offs across global markets.

Japan’s current backdrop explains why nerves are so frayed. After decades of fighting deflation, Japan finally saw inflation breach the 2% target in 2022 due to Covid and the Russia-Ukraine war, and crucially stay above that mark for three years.

To put it simply, investors borrow yen, benefitting from Japan's historically low interest rates. The borrowed yen are exchanged for another currency and invested in higher-yielding assets, such as government bonds, stocks, or real estate in countries with higher interest rates.

Profit comes from the interest rate differential; if the target asset yields more than the cost of the yen loan, the investor gains.

Risks

If the yen rises in value relative to the investment currency, investors can face substantial losses when converting back to yen to repay the loan.

Market movements or changes in global interest rates can trigger rapid unwinding of these trades, leading to volatility across currency and asset markets

Economists now expect inflation to persist, demand higher wages, and, by extension, higher interest rates. Markets have been bracing for this shift: Japanese bond yields have been climbing for two years, drawing foreign investors back to a market they had ignored for decades. The move itself wasn’t surprising, but the sudden spike in November was.

Political developments have added fuel. In October 2025, Sanae Takaichi became Prime Minister, and investors anticipated higher government spending. However, her actual plan of over 25 trillion yen ($161 billion) shocked markets. Her comments on Taiwan triggered retaliation from China, escalating geopolitical anxiety.

Markets also frowned at her remarks appearing to play down the need for rate hikes, even as inflation approached 3%. BOJ Governor Kazuo Ueda later clarified that she had not opposed higher rates during their meeting, a statement that offered some reassurance.

What’s driving the biggest fear is the potential reversal of capital flows. Japanese investors hold over $3 trillion abroad. If yields at home become more attractive, money could rush back to Japan, tightening global liquidity.

For years, the yen carry trade has shaped global capital movements. Now, even a slight shift in Japanese yields is enough to ripple across world markets, explaining the caution gripping investors everywhere.