What Is the Yen Carry Trade?

Hello, this is Bitpunk. In this post, we'll take a detailed look at what the yen carry trade is and how it actually works, with examples.

What Is the Yen Carry Trade?

A carry trade is a strategy where you borrow money from a country with low interest rates and invest it in a country with high interest rates, profiting from the difference in rates.

The yen carry trade is when this process uses the Japanese yen. In other words, it refers to approaches such as using low-interest yen to invest in high-interest dollars.

How the Yen Carry Trade Works

Japan has pursued an ultra-low interest rate policy for a long time, so the yen has been one of the most sought-after currencies among carry traders.

Here's how a yen carry trade is carried out. First, you borrow funds in Japan at a low interest rate.

Next, you exchange them into the currency of a high-interest market, such as the US dollar, and then make stable investments in things like government bonds. This lets you earn a profit from the interest rate difference.

Japan Announces Its First Rate Hike in 17 Years

Since its economic crisis in the 1990s, Japan had maintained an ultra-low interest rate policy for a long time. It even introduced negative interest rates.

The aim was to artificially lower the value of the yen and boost its export-driven economy.

However, in 2024 Japan announced its first rate hike in 17 years, and a seismic shift began.

In fact, the Bank of Japan raised rates to 0–0.1% in March, and then to 0.25% in July.

A Rising Yen and the Unwinding of the Carry Trade

As a result, the yen rose sharply in value, and a strong-yen market began to unfold.

When this happened, investors who had been running carry trades on the previously low interest rates began selling their holdings to avoid foreign exchange losses and prepare for additional interest costs. This movement is what's called 'carry trade unwinding'.

As the yen carry trade unwound, the prices of many assets fell sharply, including global stocks, emerging market currencies, and Bitcoin and Ethereum.

On top of that, hedge fund positions betting on a weak yen were liquidated en masse, greatly widening the swings in exchange rates and asset markets.

The Need for Portfolio Diversification and Hedging

So how should you respond to such rapid changes in the market environment?

It may sound like a cliché, but the most efficient and best approach is to diversify your portfolio.

For example, with a focus on a stronger yen and a weaker dollar going forward, you could consider adjusting your weighting in growth stocks and buying hedged bonds.

Wrapping Up

The yen carry trade has played an important role in global asset markets for a long time.

Recently, however, the stronger yen following Japan's rate hikes has been causing significant volatility.

Because of this, many investors are actively looking for appropriate strategies to reduce the risks that come with carry trade unwinding and exchange rate fluctuations.