The yen carry trade is increasingly being viewed as a ticking time bomb in global financial markets. This popular hedge fund strategy, which involves borrowing low-yielding yen to invest in higher-yielding assets, faces a significant unwinding risk. The threat is amplified by rising expectations for interest rate hikes from the Bank of Japan and potential policies from Minister Amari that could drive long-term government bond yields substantially higher.
This strategy has long been favored by traders for the attractive "carry" returns from overseas investments. However, it is highly vulnerable to a rapid collapse if risk assets decline, the yen strengthens sharply, or Japanese government bond yields surge unexpectedly. An increase in BOJ rate hike expectations, combined with fiscal stimulus and supply pressures pushing up long-term JGB yields and volatility, could undermine the foundation of the "borrow yen, buy high-yield assets" trade. This raises the probability of forced deleveraging during a downturn in risk sentiment.
Recent hawkish comments from several BOJ policy board members, emphasizing the need for "timely rate hikes," have rapidly fueled market bets on imminent monetary tightening. While short-term fiscal stimulus might temporarily sustain the carry trade by boosting risk appetite and keeping the yen weak, a large-scale unwinding is typically triggered by a combination of factors. These include rising rate hike expectations, deteriorating risk sentiment, and a strengthening yen, rather than any single variable.
A team of strategists at BCA Research, led by veteran Arthur Budaghyan, warns that this carry trade structure risks a rapid collapse similar to those seen in 2008, 2015, and 2020. During those periods, a swift deterioration in global risk sentiment triggered sudden deleveraging, prompting investors to rush into the safe-haven yen. BCA advises investors to take long-term long positions on the yen.
From a market mechanics perspective, the yen carry trade is most threatened by two developments: higher borrowing costs due to rising Japanese interest rates and narrowing yield differentials, and adverse currency movements where a sudden yen appreciation leads to negative carry combined with foreign exchange losses. BCA's latest warning essentially highlights that, historically, when risk asset declines and a yen rebound trigger unwinding, the two factors tend to reinforce each other, creating a powerful reversal.
In a research report dated February 10, the BCA strategists wrote, "Our sense is that the next large unwinding episode will also be triggered by a combination of a sharp decline in 'carry assets' and/or a sharp rebound in the yen. It is impossible to know which will come first. But they have tended to reinforce each other in the past, leading to a major reversal in yen carry trades." Consequently, the team recommends that medium- to long-term investors go long the yen and short the U.S. dollar.
This serves as a fresh warning for the strategy as traders monitor the potential for the BOJ to restart rate hikes later this year. So far in the current period, the yen has appreciated over 1% against the dollar, moving it away from levels that might prompt intervention by Japanese authorities. The yen is currently trading around 154.4 per dollar, a significant appreciation from near 160 last month.
BCA strategists note the difficulty in precisely estimating the scale of yen carry trades but indicate that various metrics show such positions have "expanded rapidly" in recent years and involve "substantial" amounts. They stated, "When the yen begins to appreciate, the appreciation will be large due to the widespread nature of yen carry trades."
The yen carry trade acts as a Sword of Damocles hanging over global risk assets, including equities, cryptocurrencies, and high-yield corporate bonds. This strategy is essentially a highly leveraged, cross-market financing and risk exposure. When fundamental drivers change—such as narrowing yield differentials or a strengthening yen—it can quickly become unprofitable. More critically, it can amplify market shocks through various feedback mechanisms, potentially impacting global stock markets currently hitting record highs, and even affecting global bond and currency markets.
The BOJ's prolonged ultra-low interest rate policy has made yen financing exceptionally cheap, encouraging investors to borrow yen and invest the proceeds into higher-returning risk assets like U.S. stocks, developed market bonds, and emerging market assets. This model of generating returns via low-cost yen funding has been widely adopted during periods of ample global liquidity and high risk appetite, accumulating massive leveraged positions over time.
These positions have become systemic vulnerabilities for global markets because they depend on the persistence of favorable yield spreads and a weak yen. If these conditions reverse—for instance, due to BOJ hints or unexpected rate hikes, or a decline in risk appetite—the profitability of the carry trade erodes. Crucially, when the yen strengthens, carry traders face a double squeeze: rising borrowing costs and an increase in the value of their yen-denominated debt when converted back.
To avoid losses, investors often rapidly unwind these cross-market positions by selling the previously purchased high-yield assets to repay their yen loans. This deleveraging process can swiftly drive the yen higher and depress prices of global risk assets. Given the participation of institutional investors, hedge funds, and leveraged accounts, a large-scale unwinding can trigger cascading sell-offs across equities, bonds, commodities, and credit assets.
As risk asset prices fall rapidly, market liquidity can dry up, and risk aversion can spread. Investors may then scramble for safe-haven assets like the yen, U.S. Treasuries, dollars, or gold, further accelerating the revaluation cycle from risk-on to risk-off. Historical market turmoil in 2008, 2015, and 2020 has been linked to reversals in carry trades or similar capital flow dynamics.
In essence, the carry trade represents a form of hidden leverage. When accumulated on a large scale and then reversed, its impact extends far beyond a single asset or exchange rate. It can affect the USD/JPY pair, asset prices, volatility metrics, and credit conditions through multiple market transmission channels. Highly correlated global capital flows can quickly shift toward safer assets during an unwind, forcing repricing in both stock and bond markets and potentially triggering a correlated crash across asset classes. Therefore, this risk is not merely a "single-currency issue" but a "systemic risk" with multi-dimensional triggers.