What is the Unwinding of the Yen Carry Trade? Yen Appreciation Risks Seen from 2026 Japan-US Interest Rate Differentials | Lessons from 2007 and 2024

The unwinding of the yen carry trade refers to the movement to close out transactions where funds were borrowed in low-interest yen and invested in higher-interest currencies.

Because yen are bought back to close these positions, rapid yen appreciation and stock price declines tend to occur simultaneously.

The unwinding of these trades was also behind the Nikkei Stock Average’s record single-day drop in August 2024.

1. What is the Yen Carry Trade?

It is a transaction that aims for a profit margin by borrowing funds in low-interest yen and investing them in higher-interest currencies.

A concrete example is shown in the following case.

Premise:
Borrowing 10 million yen, yen interest rate 1.00%, dollar-yen 160 yen, US interest rate 5.00%

First, borrow 10 million yen at a 1.00% yen interest rate and exchange it for dollars.
Since the dollar-yen rate is 160 yen, 10 million yen becomes 62,500 dollars.
If you invest these 62,500 dollars in US Treasury bonds or similar, you can expect a profit close to the 5.00% US interest rate (500,000 yen).
Even after paying the 100,000 yen yen interest from the 500,000 yen profit, you end up with a profit of 400,000 yen.

However, the situation changes if the yen appreciates here.
When the dollar-yen rate becomes 140 yen, the yen-denominated value of the same 62,500 dollars becomes 8.75 million yen, resulting in an exchange loss of approximately 1.25 million yen.
Even if you earn 500,000 yen in interest income at a 5% US interest rate, the loss from exchange rate fluctuations far exceeds that. Therefore, it is necessary to keep a close eye on exchange rate movements.

2. The Mechanism of Unwinding

The yen carry trade is premised on “continued yen depreciation” and “maintenance of interest rate differentials.”
If either of these collapses, investors sell dollars and buy back yen to repay the borrowed yen.
As the yen appreciates, the burden of yen-denominated debt increases, further accelerating the selling to close positions.
Stocks and other assets are also easily sold off at the same time, causing the entire market to change suddenly.

3. Lessons from the Past (1) | 2007 (Subprime Mortgage Crisis)

The 2007 yen carry trade expanded amid a large Japan-US interest rate differential. The 2007 US policy interest rate was 5.25%, Japan’s was 0.5%, and the difference reached 4.75 percentage points. The dollar-yen rate was about 123 yen in June 2007, but it turned rapidly toward yen appreciation from the end of July that year, reaching the 110 yen level by the end of the year. Subsequently, the yen was bought up to the 90 yen level in March 2009.

The turning point was the surfacing of the subprime mortgage problem. It is believed that when US housing-related assets fell in value, the funds invested there were withdrawn, and buybacks from dollars to yen surged. The yen appreciation that occurred at the beginning of the financial crisis was largely due to the reverse rotation of the carry trade.

4. Lessons from the Past (2) | August 5, 2024

On July 31, 2024, the Bank of Japan raised its policy interest rate to 0.25%. Subsequently, on August 2, the US July employment statistics fell significantly below market expectations, and the NY Dow fell by 610 dollars. In response to this, the dollar-yen rate hit the 141 yen level in the Tokyo market on August 5, the highest level of yen appreciation in about seven months. The Nikkei Stock Average closed at 31,458.42 yen, down 4,451.28 yen (12.4%) from the previous day, and the decline exceeded the day after Black Monday in 1987 (down 3,836.48 yen) to become the largest in history.

On August 6, the Nikkei average rebounded sharply by 3,217.04 yen (up about 10.2%), also recording the largest gain in history. It was an extremely volatile phase where a sharp drop and a sharp rise swapped places day by day.

5. Trends in Japan-US Policy Interest Rates

The following lists the policy interest rates at each point in time.
For the US, the interest rate differential is calculated using the center value of the target range. The dollar-yen rate is the level that could be confirmed in reports, etc.

Looking only at the interest rate differential figures, the gap has been shrinking since 2024.
However, the yen remains weak, demonstrating the difficulty of reading exchange rates based solely on nominal interest rate differentials.

6. Current status in 2026

On September 16, 2026, the Federal Reserve unanimously decided to raise interest rates by 0.25%, setting the target range for the federal funds rate at 3.75-4.00%. This marks a shift to rate hikes for the first time in 3 years and 2 months. On September 18 of the same year, the Bank of Japan also raised its policy interest rate to around 1.25%. This is the highest level in approximately 31 years, and the Bank of Japan has indicated its intention to continue raising rates in the future.

On the other hand, the market reacted in the direction of a weaker yen even after the rate hike. Following the Bank of Japan’s rate hike, the dollar-yen exchange rate saw the yen sold off, temporarily reaching the 158 yen level.

7. Points to watch

1) Speed of interest rate gap narrowing

If the Bank of Japan’s rate hikes proceed faster than expected, or if expectations for US rate cuts strengthen, a rapid yen-buying surge like the one in August 2024 could occur.

2) Policy coordination and intervention

The US Treasury Secretary has expressed the view that currency intervention alone cannot change the market and that policy implementation is necessary. Large-scale interventions or policy surprises can trigger sudden market shifts.

3) Real interest rate differentials and overseas factors

There is also a view that the real interest rate differential, which subtracts the inflation rate, influences the yen exchange rate. Additionally, rising crude oil prices due to the situation in the Middle East and US economic trends are factors that significantly move exchange rates.

8. Measures individuals can take

1) Review of leveraged foreign currency-denominated products

It is important to calculate in advance the amount of loss that would occur if the yen were to appreciate by 10-20%.

2) Check the balance between yen-denominated assets and foreign currency assets

Please check if you are overly biased toward one or the other.

3) Decide on rules for stop-loss orders and additional purchases in advance

This can reduce the risk of emotional decision-making when exchange rates change suddenly.

4) Pay attention to the Bank of Japan’s Monetary Policy Meetings, the US Consumer Price Index (CPI), and FOMC (Federal Open Market Committee) trends

Market volatility tends to increase significantly around the time of Japan and US monetary policy directions and major events.

9. Summary

The unwinding of the yen carry trade is a phenomenon that tends to occur when interest rate differentials and exchange rates move simultaneously.

The experiences of 2007 and 2024 demonstrated that yen appreciation can also spill over into the stock market.

In 2026, both Japan and the US are entering a phase of interest rate hikes, making the future of interest rate differentials difficult to predict. Do not be complacent just because the yen remains weak; anticipating ‘what will happen when interest rate differentials narrow’ is the first step toward protecting your assets.

I hope this article proves useful for your asset formation.

◆Disclaimer
This article is for informational purposes only and does not constitute solicitation, recommendation, or investment advice for any specific financial product. The content is based on information available at the time of writing and does not guarantee accuracy or completeness. Please make investment decisions at your own risk. The author assumes no responsibility for any losses or damages resulting from the use of this article.