“The yen carry trade is like dry kindling, just waiting for a spark.”
—Financial Times, April 2025
For decades, Japan’s financial quietude has served as one of the world’s most consistent assumptions: low interest rates, subdued inflation, and a central bank that could be counted on to keep borrowing costs near zero.
That assumption is now unraveling. And the consequences could ripple well beyond Tokyo.
In recent months, Japanese government bond (JGB) yields have surged to levels not seen since before the Global Financial Crisis, with 10-year yields pushing beyond 1.5%. This might seem mild by Western standards, but for Japan, a country that has spent most of the last two decades navigating deflation and ultra-loose policy, it’s a tectonic shift.
The Bank of Japan (BOJ), long the steward of yield curve control (YCC), has begun its long-telegraphed retreat from monetary exceptionalism. The world’s last remaining experiment with negative rates is over. And with this pivot comes a deeper risk, one that has experts like Société Générale’s Albert Edwards warning of a financial “Armageddon.”
At the heart of this threat lies a phenomenon called the yen carry trade.
The Machine Behind Global Risk-Taking
The carry trade works like this: Investors borrow in a low-interest-rate currency (like the yen) and invest in higher-yielding assets elsewhere, U.S. Treasuries, European debt, emerging market bonds, even equities. It’s a global arbitrage play.
Japan, with its ultra-low rates, has been the fuel station for this strategy. The BOJ’s policies ensured yen borrowing costs stayed minimal, even when inflation was roaring elsewhere. That made Japan a cornerstone of global risk appetite.
But the carry trade only works as long as the cost of borrowing remains low. When yields in Japan rise, the math changes, and quickly.
A Structural Shift in Motion
The BOJ’s policy shift isn’t just technical; it’s philosophical. After more than a decade of quantitative easing, Japan is signaling a move toward normalization, acknowledging inflationary pressures and the limits of intervention.
Bloomberg reported in March 2025 that “the BOJ’s exit from yield curve control and normalization of interest rates represents a structural shift.” Market participants took notice. Bond yields climbed. The yen, long stuck in a depreciating trend, began to show signs of strength.
That strength is what’s rattling nerves in financial capitals from New York to São Paulo.
Why Rising JGB Yields Matter Globally
Albert Edwards, the ever-watchful global strategist at Société Générale, put it bluntly in early 2025: “We are one policy misstep away from global markets seizing up.”
His concern is not abstract. When Japanese yields rise, the incentive to borrow cheaply in yen disappears. Investors unwind their carry trades, selling foreign assets to repay yen-denominated loans. This triggers:
- A surge in demand for yen, strengthening the currency
- Capital flight from emerging markets, which had depended on inflows
- Volatility spikes in equity and bond markets as liquidity dries up
In a tightly connected financial system, even modest shifts in one market can send shockwaves elsewhere.
A Reversal with Historical Precedent
This isn’t the first time the yen carry trade has haunted markets.
In 2008, as the financial crisis unfolded, the unwinding of carry trades exacerbated volatility. Japanese investors pulled funds home. The yen strengthened dramatically, contributing to losses for global portfolios already on edge.
Research by McCauley and McGuire for the Bank for International Settlements noted that carry trade unwinding was a major driver of the dollar-yen volatility during the crisis.
The same pattern risks repeating, but with more leverage and fewer policy tools left to soften the blow.
Why This Time Feels More Dangerous
The global financial system is arguably more sensitive now than it was in 2008. Consider:
- Higher Debt Loads: Governments and corporations around the world have borrowed heavily in the era of cheap money. Rising yields, even indirectly via carry trade disruptions, make refinancing more painful.
- Emerging Market Vulnerabilities: Countries reliant on foreign capital may see currency depreciation and capital outflows, just as the dollar-yen dynamic flips.
- Asset Valuations: Tech stocks, cryptocurrencies, and real estate have all benefited from abundant liquidity. A stronger yen and reduced risk appetite could deflate these valuations swiftly.
Japan itself also faces cross-pressures. Higher yields may help normalize its financial landscape, but they pose a challenge to its fiscal sustainability. Japan has the highest debt-to-GDP ratio in the developed world.
What Comes Next?
The BOJ remains cautious, but its direction is clear. And market participants are adjusting. Already, Japanese institutional investors, massive players in global bond markets, are reassessing their portfolios. If they begin repatriating funds to chase rising domestic returns, the global consequences will be immediate.
“There is no such thing as an isolated financial event in today’s world,” said economist Menzie Chinn, co-author of a foundational paper on carry trades. “Currency flows are feedback loops, not one-way bets.”
In other words: if the yen carry trade unravels, it’s not just Japan that will feel it.
Conclusion
Japan’s bond market may seem distant, even obscure. But its awakening could mark the start of a new phase in global finance, one where the assumptions of the past 15 years no longer hold.
Rising JGB yields aren’t just a local story. They are a signal that one of the pillars of global risk-taking is shifting. And in a world already nervous about inflation, debt sustainability, and market fragility, that shift could become the tremor that shakes the entire system.
Sources
- Bloomberg, March 2025 – “Japan’s Bond Market Awakens as BOJ Exits YCC”
- Financial Times, April 2025 – “Why Rising JGB Yields Threaten Global Risk Appetite”
- Société Générale, Albert Edwards client commentary, 2025
- Fujii, E., & Chinn, M. D. (2009). Carry trades and the uncovered interest parity puzzle. Journal of International Money and Finance, 28(8), 1175–1197. DOI link
- Hattori, M., & Shin, H. S. (2009). Yen carry trade and the global credit crisis: A firm-level analysis of Japanese exporters. BIS Working Papers No. 283. BIS Link
- McCauley, R. N., & McGuire, P. (2009). Dollar appreciation in 2008: Safe haven, carry trades, dollar shortage and overhedging. BIS Quarterly Review. BIS Link
