End of Yen Carry Trade Era as BoJ Raises Rates

The Japanese yen's long run as a source of ultra-cheap funding for global investors appears to be ending, raising questions about the future of the carry trade strategy.

For years, Japan's central bank kept interest rates near zero to combat deflation, making the yen an ideal currency for borrowing. Investors would take low-cost yen loans, convert them to higher-yielding assets like US bonds or emerging market debt, and pocket the interest rate differential—minus fees and exchange rate risks. The strategy thrived as long as the yen stayed weak or stable, but it unravels when the currency strengthens or borrowing costs rise.

That shift began in earnest in 2025. In late January, the Bank of Japan (BoJ) set its policy rate around 0.5%. By December 19, it hiked the rate to 0.75% and signalled further increases if inflation and economic activity met expectations. Japanese government bond yields saw their largest annual jump since 1994, driven by reduced BoJ bond purchases and anticipation of more tightening.

Early 2026 data underscores the fragility. The dollar traded near 157 yen, reflecting a wide interest rate gap with the US Federal Reserve's range of 3.50%-3.75% at the end of 2025. Yet tighter BoJ policy, combined with global market uncertainty, could squeeze profits. The yen's status as a traditional safe-haven currency often strengthens it during turbulence, making loan repayments costlier.

A mass unwind could trigger a domino effect: investors sell foreign assets to buy back yen, pushing the currency higher and forcing more closures. Even without panic, higher funding costs alone promise ripples across currencies, stocks, and credit markets.

Looking ahead, the BoJ's path hinges on wages and prices. It expects inflation to dip below 2% in the first half of fiscal 2026 before gradually rising, while company surveys point to salary growth similar to 2025 levels. This suggests short-term caution but data-dependent hikes, keeping rates elevated compared to prior years.

Japan has long been the world's cheapest funding factory for carry trades. With that era fading, investors face reduced fuel for the strategy and heightened volatility as positions adjust.