History of the Yen Carry Trade — A Quiet River and a Sudden Flood

The yen carry trade is a strategy of borrowing the near-zero-interest Japanese yen and investing in higher-interest currencies and assets of other countries to earn that interest-rate gap.

Japan maintained ultra-low interest rates (sometimes negative rates) for a long time after its asset bubble burst in the 1990s. So the yen became the world's most popular 'funding currency (the currency you borrow).'

From hedge funds to individual investors, the trade of borrowing cheap yen and putting it into higher-interest places—Australian dollars, U.S. Treasuries, emerging-market assets—continued for decades. Because these funds are woven throughout global financial markets, the yen carry is called a 'quiet but enormous' flow.

The yen carry trade steadily earns the interest-rate gap during calm times. If the yen stays weak, the interest-rate gain can be joined by an exchange-rate gain as well.

The problem is when the 'unwind' piles up. When a crisis comes or signs appear that Japan will raise rates, a flow arises of selling investment assets all at once and buying back yen to repay the borrowed yen.

At this time two things happen at once. Global assets are sold and prices fall, and the yen surges. When the yen surges, even those who have not yet unwound face growing losses and also rush to unwind. This chain creates the 'flood.'

One reason the yen is counted as a 'safe-haven currency' that strengthens in a crisis is precisely this unwind flow. The more frightened people are, the more yen demand piles up.

The most vivid recent case is the summer of 2024.

On July 31, 2024, the Bank of Japan (BOJ) raised its policy rate to about 0.25%. The hike itself was small, but it was in a direction that departed from market expectations. On top of this, a weak U.S. jobs report in early August combined, compressing an unwind that would have taken months into just a few days.

As a result, on August 5, Japan's Nikkei 225 index plunged about -12.4% in a single day. It was the largest daily decline in history, surpassing Black Monday 1987, and from July 31 to August 5 it collapsed about -20%. The fear index (VIX) spiked to 65 intraday, and the U.S. S&P 500 also fell about -6% over three trading sessions.

However, the market rebounded quickly afterward. Here comes an important lesson. The problem is 'leverage' more than the size of the decline. Someone who invested with borrowed money can be forcibly liquidated in the plunge and end up locking in a loss without even enjoying the subsequent rebound.