December 5, 2025 | The Yen Carry Trade Unwind Threatens Global Markets

The Shifting Dynamics of the Yen Carry Trade

The central thesis is that the decades-long assumption of near-zero Japanese interest rates and a weak Japanese yen (JPY)—the two pillars of the yen carry trade—are now collapsing.

1. The Historical Carry Trade Setup

• Borrowing: Traders borrowed vast sums in Japanese yen at a near-zero interest rate.
• Investing: They converted the borrowed yen into other currencies (like USD) and invested in higher-yielding assets globally, such as U.S. government bonds, stocks, and even speculative assets like Bitcoin.
• Profit (The “Carry”): The profit was the difference between the high yield on their investments (e.g., U.S. Treasury rates) and the minuscule cost of borrowing in Japan.
• Low Risk (Historically): Risk was minimal as long as the Japanese interest rates stayed low and the yen remained weak against the dollar. This created an environment for traders to use large amounts of leverage, magnifying their enormous profits.

2. The Disaster-in-the-Making: The Unwind

The current economic shift in Japan directly attacks both pillars of the carry trade, creating a double whammy for leveraged speculators:

• Rising Interest Rates:
  • Japanese Inflation: Japanese inflation has consistently stayed above the Bank of Japan’s (BOJ) 2% target (the rate was at 3.0% as of October 2025).
  • BOJ Policy Shift: With inflation stubbornly high, the BOJ is being forced to consider raising its benchmark rate (the market has priced in an 81% chance of a December hike, according to one report, and the current rate is 0.5% as of October 2025)
  • Impact: A rate hike increases the cost of borrowing the yen, eating directly into the carry trade’s profit margin.

Source: St. Louis Fed – FRED

• Appreciating Yen (Currency Risk):
  • Yen Strengthening: The yen has already appreciated by 10% since July 11th.
  • Impact: When a carry trader unwinds the position, they must convert their USD-denominated assets back into yen to repay the original loan. If the yen has strengthened, they get fewer yen back for each dollar, resulting in a currency loss that compounds the higher interest cost.

3. The Systemic Risk (The “Crowded Theater”)

The core danger is the “yelling fire in a crowded theater” effect. What happens when everyone heads for the exit at the same time?

• Trillions at Risk: The sheer volume of this trade is estimated to be in the trillions of dollars, involving not just hedge funds but also banks, life insurance companies, and pension plans that became complacent.
• Forced Liquidation: If the BOJ is perceived as being on a path of sustained rate hikes and/or the yen continues to strengthen, traders will be forced to unwind their positions to mitigate losses.
• Global Selling Pressure: This mass unwinding means simultaneously selling the assets they bought—U.S. bonds, stocks, Bitcoin, etc.—to raise the dollars needed for conversion. This selling pressure could depress global asset prices, adding an extra worry to an already nervous U.S. market.

Watch what the BOJ does with interest rates at its December 18^th meeting.

Hilliard MacBeth

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Hilliard MacBeth December 5th, 2025

Posted In: Hilliard's Weekend Notebook

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