Yen carry trade risks grow as Japan shifts policy

Japan’s retreat from decades of ultra-loose monetary policy has coincided with a large expansion in yen-funded borrowing. Jefferies estimates outstanding cross-border yen borrowing climbed about 67% to roughly JPY360 trillion ($2.3 trillion) between December 2021 and March 2026. Hedge funds, banks, companies and households increased yen-funded leverage while domestic interest rates remained low.

The strategy, known as the yen carry trade, involves borrowing yen at low rates and investing the proceeds in higher-yielding assets abroad. Managers have used yen funding to finance positions in global equities, bonds, emerging-market currencies and other risk assets.

The vulnerability appears when the yen strengthens or Japanese interest rates rise. Investors reducing leverage typically sell the assets bought with yen funding and buy back yen loans. Those flows can push down prices for the assets sold and lift the yen.

Markets experienced a rapid unwind in 2024, when a stronger yen and shifting expectations about Bank of Japan policy led to quick deleveraging. The episode included a sharp one-day fall in Japanese equities and losses in technology stocks, cryptocurrencies and several emerging-market currencies. The Bank for International Settlements found markets had become unusually sensitive to changes in expectations for economic growth and monetary policy.

Measuring the full scale of yen-funded positions is difficult because much activity runs through derivatives and opaque funding structures that are not fully visible to regulators. Commodity Futures Trading Commission data show speculative short positions in the yen were rebuilt during 2026 after being pared back in late 2024 and early 2025, with positioning only beginning to unwind again in recent weeks.

The risks extend beyond hedge funds. Citi estimates Japanese foreign direct investment — including equity capital, reinvested earnings and debt capital — reached JPY384 trillion in 2025, equivalent to more than half of Japan’s GDP. Citi also finds non-financial Japanese companies now hold more overseas assets than the country’s banks, pension funds and insurers.

Jefferies quantitative analyst Shrikant Kale described the build-up as “the largest carry-trade cycle of the past three decades.” Regulators and market participants are monitoring positioning data and corporate flows for signs that leveraged yen exposure is starting to unwind.