EXPLAINER - What is the yen carry trade?

The yen carry trade is a global investment strategy involving borrowing the Japanese yen at low interest rates and investing the funds in higher-yielding currencies such as the US dollar, Mexican peso, New Zealand dollar, or other emerging market currencies. This trade has been a prominent force in global markets since 2013, initially driven by Japan's quantitative and qualitative easing measures, rising US rates, and a depreciating yen.

The strategy typically yields annualized returns of 2.5% to 3.5%, which is lower than its peak of 5% to 6% in 2024. However, the strategy is vulnerable to shifts in investor sentiment and expectations of accelerated rate hikes by the Bank of Japan (BOJ).

Recently, with the yen's surge to a seven-month high, investors are considering alternatives like the Swiss franc as a funding vehicle. The BOJ's anticipated rate hike, coupled with orderly market responses and the yen's devaluation, signals a potential transition in the yen carry trade. This shift could have significant ramifications for global markets, as evidenced by the BOJ's July 2024 rate hike, which forced traders to unwind positions and led to a 12.4% drop in Japan's Nikkei index.