Yen Carry Trade Under Threat as BOJ Hikes Loom

The yen carry trade is a financial strategy that involves borrowing Japanese yen at low interest rates to invest in higher-yielding assets. The strategy has been a staple of global markets for years, but its stability is now being threatened by expectations of accelerated rate hikes by the Bank of Japan (BOJ).

Investors use the borrowed yen to buy currencies with better yields, such as the US dollar, Mexican peso, or New Zealand dollar. The trade typically lasts a short period, after which the investor converts the proceeds back into yen and repays the loan.

The annualized returns on dollar-yen carry trades can be around 2.5% to 3.5%, but that's lower than the 5% to 6% seen in 2024. The BOJ's rate hike signals have been clear, but investors are still wary of a sudden reversal, which could have significant repercussions for global markets.

The carry trade is difficult to quantify, but cross-border yen borrowing jumped to a record 360 trillion yen ($2.34 trillion) as of March. This marks the largest carry-trade build-up in three decades. Meanwhile, net shorts on the yen were 92,227 contracts in the week to September 1.