Why the Yen Carry Trade Threatens Global Markets

The unwinding of the Yen carry trade is a looming threat to global markets. If it happens. Wondering what the Yen carry trade is? You are not alone. Fortunately, this infographic does a great job answering the first question: Why the Yen?

It is advantageous to borrow money in Yen, then use that money to purchase USD or other non-yen denominated assets that outperform the loan rates by a wide margin, making repayment basically effortless. Given the low interest rates and perceived safety of the JPY, this strategy has been employed for decades. However, it can run into problems that force the participants to liquidate the non-yen assets. That is the “unwind.”

Carry trade unwinds are not orderly events at all. In fact, they are among the most disorganized and unhinged market events because of the cascading effect they cause. Think of it as a feedback loop of financial disaster. Consider this infographic of an unwind:

The Yen carry trade unwinds quickly due to monetary policy shifts, such as Bank of Japan (BoJ) tightening, Fed easing, Yen appreciation, or risk-off sentiment. This triggers a chain reaction: altered risk-reward, profit erosion/losses, margin calls/forced selling, increased Yen demand for loan repayment, and a Yen appreciation feedback loop. The Yen's role as a cheap funding currency and safe haven intensifies these risks during risk-off periods, causing capital to flow into Yen, appreciating it and further damaging carry trades.

The Primary Participants of the Carry Trade

Here are the entities that are the biggest participants in the carry trade.

Hedge Funds & Speculators: Often at the forefront, using leverage to maximize returns from interest rate differentials and currency moves.
Global Banks: Borrowing Yen for funding advantages or facilitating trades for clients.
Institutional Investors: Pension funds, insurance companies, etc., seeking enhanced returns or diversified funding.
Japanese Investors: Historically sought higher yields abroad due to low domestic returns.
Retail FX Traders: Smaller individual positions but collectively can influence market dynamics due to the highly leveraged nature of FX trading.

These institutions and investors have an incredible amount of money at risk on a carry basis. How much? No one is sure. Best guess places the average at about $4T, but it could be as high as $20T. An unwind of that magnitude can have disastrous consequences for the global markets. The following infographic illustrates how badly global assets could be impacted:

There have been serious carry trade unwinds over the years that have resulted in extraordinary damage to markets. The infographic below illustrates three examples over the past 27 years. It is interesting that the 2007-2008 unwind event played a role in the worsening of the global credit crisis, and a significant role at that. But it is never mentioned as it is lumped in with all the deleveraging that happened at the time.

Look at the 2024 event. The characteristics that triggered that event are still present today. Some would argue that, given the current strength of the Yen and the rapidly rising yields of Japanese bonds, it is only a matter of when, not if, an unwind event occurs.

The Cause for The Recent Unwind Concern? Rising Japanese Bond Yields

A driver of the current unwind risk is the surge in Japanese government bond (JGB) yields, especially on longer maturities, which have surged to record or near-record highs. This combined with the BoJ moving away from an extremely loose monetary policy has sparked serious concern. Recently, Japan held a 20-year debt auction that was considered a failure, having the worst demand since 2012. This is one of the primary causes of the recent surge in not only the yield on all maturities of Japanese debt but a surge in the value of the Yen. Rising global bond yields are a big problem and yields are currently on the rise in the US, the UK, the EU and of course, Japan.

Implications of Rising Global Bond Yields:
- Higher Borrowing Costs: More expensive for governments, companies, and households, potentially slowing economic growth.
- Fiscal Strain: Governments with large debts face higher interest payments.
- Financial Market Volatility: Rising yields trigger volatility and repricing of risk in stock markets and other assets.
- Potential Negative Feedback Loop: Rising yields increase debt service costs and deficits, potentially leading to even higher yields.

How Likely is an Unwind, Really?

As of May 2025, experts assess that the risk of a major unwinding remains elevated.

Heightened Risk: Due to lingering effects of 2024 unwinds, ongoing BoJ policy normalization, U.S. Fed policy uncertainty, Yen valuation concerns, and bond market stresses.
Concerns: Strong warnings about the potential severe impact on U.S. Treasuries (read "could crater") and the possibility of gold reaching new record highs. The unwinding is casting a shadow over equities.
IMF Assessment: The IMF assessed in April 2025 that global financial stability risks have "increased significantly," citing tighter financial conditions, uncertainty, including from trade tensions. They noted that the unwinding of leveraged trades had contributed to the straining of already challenged market liquidity.
Systemic Risk Amplification: The current environment presents a risk where the carry trade unwind acts as a transmission mechanism, potentially leading to a more systemic crisis. Not unlike 2007-2008.

A Critical Juncture for Global Finance

Rising JGB yields, BoJ policy shifts, and global uncertainty threaten to unwind the significant Yen carry trade, a risk amplified by increasing global bond yields due to fiscal concerns and less central bank support. While the timing and severity are uncertain, historical precedents and expert opinions suggest potential global market disruption across currency, equity, and bond markets, with specific risks for the U.S. economy and Federal Reserve policies.

Increased vigilance, proactive risk management, and policy preparedness are necessary given the potential for this unwind to trigger broader systemic issues, as highlighted by the IMF's concerns about leveraged trades and global financial stability. The Yen carry trade poses a substantial threat requiring careful attention.

The AI Carry Trade Unwinds