The Yen Carry Trade and Why It Always Unwinds Badly

The trade sounds almost too simple. Borrow yen at 0.1% interest. Convert to Australian dollars or Turkish lira or Mexican pesos. Invest in that country's bonds at 5% or 8% or 12%. Pocket the spread. Repay the yen loan later.

For two decades after the Bank of Japan adopted near-zero interest rates in the late 1990s, this worked — most of the time. The catch is packed into those last four words.

Carry trades earn small, consistent returns until the funding currency strengthens. If the yen appreciates against the target currency, the cost of repaying the yen-denominated loan rises in local terms. A 10% currency move can wipe out years of interest rate differential in days. Traders who use leverage — and the carry trade almost always involves leverage — face margin calls and must close positions quickly. Their selling accelerates the currency move, triggering more margin calls elsewhere. The unwind is self-amplifying.

In August 2024, the Bank of Japan raised its policy rate from 0.1% to 0.25% — a tiny move by any standard. The yen had been near 160 per dollar. Within two weeks it strengthened to roughly 142. Traders who had borrowed yen to buy equities globally — particularly US tech stocks and emerging market bonds — unwound positions simultaneously. The Nikkei fell 12% in a single day on August 5, 2024, its worst single-day drop since 1987. US equity markets fell sharply in sympathy before recovering.

The size of the yen carry trade is never precisely known because most of it lives in derivatives and off-balance-sheet positions. That opacity is part of what makes the unwind so sharp: no one knows who is leveraged and how much until they all sell at once.