Yen Carry Trade

Definition

An investment strategy involving borrowing Japanese Yen at low interest rates to invest in higher-yielding assets in other currencies.

Primary Goal

To profit from the difference in interest rates between the borrowed Yen and the invested currency.

Primary Driver

Japan's historically low interest rates maintained by the Bank of Japan.

Associated Risks

Exchange rate fluctuations, sudden market shifts, forced liquidations, margin calls.

Funding Currency

Japanese Yen (JPY)

Estimated Market Size

Between $1.1 trillion and $4 trillion

Common Investment Currencies

US Dollar, Mexican Peso, New Zealand Dollar

2007

2007-2008

A Yen carry trade is an investment strategy where investors borrow money in Japanese Yen, which typically has low interest rates, and then convert it into a currency with higher interest rates to invest in higher-yielding assets. The goal is to profit from the difference in interest rates between the two currencies. [...] The Yen carry trade was an attractive strategy because Japan has maintained very low interest rates for an extended period. This low cost of borrowing allowed investors to leverage their positions significantly. By borrowing large amounts of Yen and investing in higher-yielding assets, investors could achieve significant gains. The strategy had only become more attractive in recent years as other developed economies raised interest rates, resulting in a more substantial differential. In [...] The unwinding of Yen carry trades didn’t just affect Japanese markets.Since many investors used the borrowed Yen to invest in global assets, the sell-off spread to other markets, amplifying the downturn. The rapid changes in the Yen’s value and the subsequent sell-off in global markets increased overall market volatility.This heightened uncertainty further eroded investor confidence, contributing to the market crash.

The trade involves buying the higher-yielding currency with the borrowed yen to invest in bonds or other money market instruments in that currency. At the end of a usually short-term trade, the investor converts the dollars or pesos back into yen, and repays the loan. Annualised returns typically can be around 5% to 6% on dollar-yen carry trades, which is the difference between U.S. and Japanese rates, with a scope for more gains were the yen to depreciate during that term. [...] Skip to main content # Explainer: What is the yen carry trade? By Vidya Ranganathan SINGAPORE, Aug 7 (Reuters) - Global stock and bond markets, in particular Japan's, are being rocked by an unwinding of the hugely popular yen carry trade. That trade, which involves borrowing yen at a low cost to invest in other currencies and assets offering higher yields, is being wrecked by Japan's rate increases, a volatile yen and imminent rate cuts in the United States and other economies. [...] Make sense of global markets with the Trading Day newsletter. Sign up here. Here is a deeper look at the yen carry trade. Advertisement · Scroll to continue ## HOW DOES THE CARRY TRADE WORK? It involves borrowing the yen , or any other currency with similar super-low interest rates, then using it to buy currencies with better yields. The yen has been the funding currency of choice for carry trades in U.S. dollars, Mexican pesos , New Zealand dollars and some others.

To give you some perspective, analysts have estimated that the yen carry trade could be worth anywhere between $1.1 trillion and $4 trillion. That’s a huge sum of money tied to a single strategy, and when that starts to unwind, you can imagine the waves it creates in the market. ##### Should You Be Worried? [...] It’s easy to feel a little jittery when you hear about market volatility and the potential unwinding of trades that involve trillions of dollars. But take a breath – these things are part of the ebb and flow of the financial world. While there’s no doubt that we’re in a period of adjustment, many believe that the yen carries trade isn’t completely over. Some experts even suggest that it could still be profitable in the long run.

## Example: The 2024 Japanese Carry Trade Unwinding The yen carry trade, a popular strategy among investors, involves borrowing funds in Japanese yen—historically known for its low interest rates—and investing in higher-yielding assets such as U.S. Treasury or stocks. The 2024 market correction triggered by the unwinding of yen-related carry trades was not unprecedented. [...] A similar scenario unfolded during the 2008 financial crisis. By 2007, the Japanese yen carry trade had ballooned to an estimated $1 trillion, as investors capitalized on Japan's near-zero interest rates to fund investments in higher-yielding assets globally. However, as the global economy lurched toward the abyss from 2007 to 2008, the widespread collapse in asset prices led to a rapid unwinding of these yen carry trades. [...] Carry trades are sophisticated investment strategies that exploit interest rate differentials between currencies. While potentially lucrative, they carry significant risks because of exchange rate fluctuations and the possibility of sudden market shifts. The 2024 yen carry trade unwinding demonstrates how changes in monetary policy, such as the Bank of Japan's interest rate hike, can trigger widespread market disruptions.