Yen Carry Trade: Why Everyone Is Talking

Before we get to the yen carry trade, it helps to understand what a carry trade is and why people are focusing on the yen.

What Is a Carry Trade?

A carry trade is an investment strategy of borrowing money at a lower interest rate and investing it in an instrument that offers a higher interest rate. For example, if someone borrows Rs 1 lakh at an interest rate of 3% and invests in an instrument that gives 7%, the difference is 4%. The gain, excluding taxes and fees, is roughly:

Carry = Investment return − Borrowing cost

There are four combinations of borrowing and investment rate types:

A carry trade can happen within the same country, with the same currency, or between countries with different currencies. In the first case, there is no currency conversion risk involved. This same-currency version is called a positive carry trade or a spread trade — the same mechanism behind arbitrage funds.

The borrowing and investment sides do not have to be the same type of instrument, or both fixed-rate. Within the same country, for example, one could borrow from a bank and invest that money in an instrument with high return potential, such as stocks. This carries high risk — if the investment does not reliably earn a high enough return over the borrowing cost, the chance of a loss is higher. This is a case of a fixed-rate borrowing cost paired with a variable-rate investment.

If the loan is at a floating rate and the investment is a fixed-rate bond, the outcome can go either way. For example, someone takes out a loan at 8% and invests in a bond returning 11% for the same duration; if the Reserve Bank of India cuts the repo rate and the borrowing cost falls, the trade can earn a good return. The reverse, though, can cause a loss. Used deliberately, this can be a useful technique — take out a floating-rate loan when interest rates are high, invest in a fixed-rate bond, and benefit as the floating rate gradually falls once the RBI cuts the repo rate.

Currency Carry Trades

A currency carry trade works the same way, except the borrowing and the investment are in different currencies — so the exchange rate now affects the return as well.

For example, borrow $1,000 in the US at a 4% interest rate and invest it in an Indian bond that yields 7%. Suppose the exchange rate at the start is 1 USD = Rs 95. There are three possible scenarios. If at maturity the exchange rate stays the same, there is a clear profit of 3% per year, about $30, excluding taxes and fees.

If the exchange rate becomes 1 USD = Rs 90, the rupee has appreciated. The invested amount grows to about Rs 101,650, and at Rs 90 per dollar the output is about $1,129.44. The repayment is $1,040, so the difference is $1,129.44 − $1,040 = $89.44.

Investors can earn from both the interest rate difference and rupee appreciation. This is a technique many foreign investors use in emerging markets — they target currencies that are currently depreciated but expected to appreciate soon.

The reverse can also happen. If the rupee instead depreciates to Rs 100 per dollar, the output is Rs 101,650 / 100 = $1,016.50, and the difference becomes −$23.50.

Why the Yen Carry Trade Is Popular

The yen is the best funding currency for several reasons.

1. Japan has had extremely low interest rates for many decades, near zero, so the difference between its rates and other countries' rates is large and consistent. For example, US bond yields are high while the dollar remains a globally stable currency — a combination that draws yen borrowing toward it. Investors in Japan, such as banks, pension funds, and households, borrow yen and invest in global markets such as US bonds. Because of the large difference, they keep accumulating positions.

   When the yen is weak or steady, there is no issue. But when the yen strengthens, investors may sell foreign assets and buy yen to repay the borrowing. Many of these carry trades use leverage, and unwinding the positions can accelerate the decline in global stock markets. If markets panic, many traders close their positions — voluntarily or forced by leverage — and buy yen to cover, which strengthens the yen further and can trigger another global sell-off.

2. Historically, the yen has had very low interest rates, deep global markets, and easy international convertibility, all considerably ahead of the rupee. Indian banks and financial institutions have regulatory limits on their foreign currency exposures and overseas transactions. Rupee borrowing is concentrated mostly in India. Outside India, rupee products exist — such as rupee-denominated bonds and currency derivatives — but in very small size compared with other currencies.

Why This Is Happening Recently

Recently, the yen was at a 40-year low against the US dollar, at 163 yen per dollar, which encouraged investors and traders to pursue the yen carry trade. However, this weak yen created inflation in Japan — food and other goods became more expensive.

To strengthen the yen, Japan and the US bought it together, moving it from 163 to 155 per dollar — a gain of about 5% in a very short period. It then weakened again toward 160, though the US could step in once more to stabilize it.

In addition, the Bank of Japan raised its policy rate to 1% in June 2026, and it may raise the rate again in September 2026. This could hurt carry traders further — if the US intervenes again and higher interest rates strengthen the yen, unwinding these positions becomes more expensive.

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Summary

The yen carry trade works because Japan's rates have stayed near zero for decades while the yen remains deep and easy to convert, so borrowing yen to invest elsewhere has stayed profitable and consistent. That same gap is what makes it risky: a stronger yen forces leveraged positions to unwind, and a fast, coordinated unwind can spill into global markets. With the yen near a 40-year low, joint intervention already pulling it back once, and the Bank of Japan raising rates in 2026, that gap is narrowing — which is exactly why the trade is back in the news.

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References

1. Reserve Bank of India
2. Bank of Japan

This article is for educational and informational purposes only and does not constitute investment advice. Please consult a registered investment adviser before making any investment decision.