4 reasons the Yen Carry Trade could blow up - In Layman's Terms
And 4 Major Consequences as a result
This post will look at a carry trade and, specifically, the Yen Carry Trade.
It will explain what both of them are and then give 4 reasons why it could blow up moving forwards.
It will then look at the 4 major consequences of such an event happening.
This is part of the Layman’s Terms series, which is an attempt to make macroeconomic ‘jargon’ simple :-)
The graphs/charts have been produced by Chat GPT.
What is a Carry Trade?
In a nutshell, you can borrow money really cheaply in one country i.e. Japan (because interest rates are very low) and use that money to invest in another country where the interest rates are much higher i.e. USA
You make money from the difference in the interest rates.
That is a carry trade.
What is the Yen Carry Trade?
The Yen Carry Trade is the above and is called so because:
1 - The Yen is the currency of Japan
2 - Interest rates in Japan are still very low
3 - People have been borrowing in Yen and then investing in other countries i.e. USA
4 Reasons why the Yen Carry Trade could blow up
NB - The most popular yen carry trade is to either the USA or Australia, hence why the focus throughout is on these 2 countries.
1 - The Yen Suddenly Gets Stronger
If you borrowed in Yen and invested in US Dollars, you need to pay back the Yen eventually.
However, if the Yen suddenly becomes stronger (compared to the dollar), it now costs more dollars to buy back the same amount of Yen.
This either eats into profits or, even worse, can give you a loss.
Simple example:
You borrow ¥100 when $1 = ¥100 → you get $1.
Later, $1 = ¥90 → to pay back ¥100, you now need $1.11
This might sound trivial but bear in mind that people will do this using millions (and potentially billions) of US Dollars. Therefore, a tweak in the Yen can potentially have major ramifications.
2 - Interest Rates Rise in Japan
If Japan suddenly raises interest rates, borrowing Yen becomes more expensive.
The whole reason the trade works is because rates in Japan are lower than those in the USA.
If that changes, the carry trade becomes less profitable—or eventually not profitable at all.
The graph below illustrates interest rates in Japan compared to those of the USA and Australia.
3 - Market Panic or Global Crises
When global markets panic, investors usually rush into safe assets.
One of those “safe” places is... the Yen. This is because the Japanese economy is deemed stable.
That demand pushes the Yen higher, which again makes it more expensive to pay back what was borrowed.
Panic = stronger Yen = trouble for the carry trade.
Hot wars, interest rate issues and general crises are upon us.
This will lead to higher volatility (as has been seen since April 2025) and thus could blow up the trade.
4 - Too Many People Doing It (Crowded Trade)
When everyone jumps into the same trade, it can create a bubble.
If something goes wrong, everyone runs towards the same exit. This will make the Yen shoot up even faster (see point 1).
This is called a "crowded trade"—and when it unwinds, it can and will crash hard.
As mentioned in point 1, investors/hedge funds et al are likely doing this in the millions and billions of Yen/USD.
4 Major Consequences
1 - Investors Lose Money Fast
When the Yen suddenly strengthens or interest rates rise in Japan, investors who borrowed Yen and invested elsewhere have to pay back more than they expected.
This will likely mean:
Losses (potentially substantial losses)
Margin calls (brokers demanding more money)
Some hedge funds/investment firms might collapse
2 - Mass Unwinding = Market Panic
When the carry trade stops working, everyone will rush to "unwind" their positions at the same time.
This means:
Selling off investments (stocks, bonds, etc.) in other countries
Buying back Yen to repay loans
Causing market crashes and currency spikes (causes a potential death spiral)
3 - Currency Shock Hits Markets
Using the USA and Australia as part of the trade, when the carry trade unravels:
Those countries see money flee rapidly
Their currencies drop (lower DXY etc)
Interest rates rise, inflation spikes
Economic pain follows
NB - Does this sound familiar?
4 - Central Banks May Step In
When point 3 happens, then it is likely that the central banks (in this case the Bank of Japan and/or the Federal Reserve) might:
Intervene in currency markets
Change interest rates
Provide emergency liquidity
This can just add to the uncertainty, and most of the time it is a case of too little, too late.
I hope that you have found this useful.
Another example of how the wealth gap will continue, no matter what