Yen Carry Trade Faces Biggest Challenge Yet Amid BOJ Rate Hike Expectations

The yen carry trade, a cornerstone of global markets for years, is facing its biggest challenge yet. With Japan's currency hitting a seven-month high, investors are wondering if this signals the end of the trade that has been driving returns on higher-yielding assets.

The strategy involves borrowing yen at low interest rates to invest in currencies with better yields, such as US dollars or Mexican pesos. This allows investors to earn around 2.5% to 3.5% annualised returns on dollar-yen carry trades, although this is lower than the 5% to 6% seen in 2024.

However, expectations of accelerated rate hikes by the Bank of Japan (BOJ) as early as next week are undermining the trade. The BOJ's recent signals have led to orderly gains in the yen, suggesting a shift in investor mindset ahead of the pivotal meeting.