CluenexWhat is the yen carry trade?
The yen carry trade is borrowing Japanese yen at low interest rates, converting the money into another currency, and investing it in assets that pay more. Those assets can include US Treasury bonds, US stocks and other currencies.
The trade earns money when the return on the foreign asset is bigger than the cost of the yen loan, and when the yen does not rise enough to erase the gap. For many years Japan kept its policy rate (the short-term rate the central bank controls) at or below zero to fight falling prices. That made yen unusually cheap to borrow.
A simple example with round numbers: borrow 1 million yen at 0.1% and invest it abroad at 4%. The yield gap is 3.9 percentage points, so about 39,000 yen of gross profit a year. If the yen then rises 5% against the currency you invested in, that currency move costs about 50,000 yen when you convert back, and the loss wipes out the profit.
How does a BOJ rate hike reach US markets?
A hike raises the cost of yen loans and narrows the yield gap, so some investors close their trades. Closing a trade means selling the foreign asset, buying yen and repaying the loan.
Buying yen pushes the yen up, which hurts everyone who still holds the trade. That creates a feedback loop: a stronger yen causes more closing, which causes a stronger yen. Leveraged investors (those who borrowed to invest) may also face margin calls, which are broker demands for more cash or forced sales.
Selling pressure lands on whatever those investors owned, and that can include US stocks. Retirement accounts feel it indirectly through the index funds, target-date funds and ETFs that hold those stocks.
What happened in August 2024?
On July 31, 2024, the BOJ raised its policy rate from a range of 0% to 0.1% to about 0.25%, and signaled that more hikes could follow. The yen had been near 161 per dollar in early July and began climbing quickly.
On August 5, 2024, the Nikkei 225 fell 12.4%, its worst one-day percentage drop since 1987. The S&P 500 fell about 3% the same day, and the VIX, the index of expected US stock volatility, closed near 38.6 after spiking far higher during the session.
On August 7, Uchida said the BOJ would not raise rates while markets were unstable. Markets then recovered much of the loss over the following weeks.
The Bank for International Settlements studied the episode in BIS Bulletin No. 90. It treats the yen carry trade as one contributor among several, alongside weak US jobs data and crowded positioning, rather than the single cause.
Does Japan's Treasury holding matter too?
Yes, but it works slowly. Japan is the largest foreign holder of US Treasury securities, according to the US Treasury's TIC (Treasury International Capital) data. Japanese insurers, pension funds and banks bought them partly because domestic bond yields were so low.
As Japanese government bond yields rise, some of that money has a reason to stay home. Less foreign demand can mean US Treasury yields need to be a bit higher to attract other buyers. Higher yields compete with stocks for investor money and lower what future profits are worth today. The effect builds over months, not in one session, and it is only one of many forces on Treasury yields.
For how central bank decisions flow into stocks more broadly, see How Fed Interest Rate Decisions Affect Stock Prices.
Where does this idea fail?
The carry trade story is a useful lens, not a forecast tool. Several limits matter.
- Not every hike causes a scare. The shock in 2024 came from surprise plus crowded positioning. Hikes that markets expect, and that arrive with calm guidance, have usually passed with far smaller moves.
- Size is hard to measure. Much carry trade activity runs through derivatives and private leverage, so no one knows its exact scale at any time.
- It is rarely the only cause. The 2024 selloff also involved US growth worries. Pinning a whole market move on one central bank oversimplifies it.
- The trade can come back. As long as Japanese rates sit well below rates elsewhere, the incentive to borrow yen remains, though it shrinks as the gap narrows.
- Current numbers change. The BOJ policy rate and its meeting schedule move over time. Always read the latest decision on the bank's website instead of trusting a figure in an article.
What does a BOJ decision change for a retirement account?
Usually very little, and rarely in a way you can predict. The exposure is indirect: broad stock funds hold companies whose share prices can drop when leveraged investors are forced to sell, and international funds change in dollar value when currencies swing.
The yen matters most for Japanese holdings. If a fund owns Japanese stocks and the yen strengthens, the dollar value of those holdings rises. If the yen weakens, it falls, even if the companies did nothing different.
What this means for you
If you have a regular job and a brokerage or retirement account, the useful habits are simple and calm.
- Know what your funds hold. Open your fund fact sheets and check how much is international and how much is Japan. That tells you how exposed you are to yen swings.
- Know the dates. The BOJ publishes its meeting schedule and decisions on its website, and the Federal Reserve publishes daily exchange rates in its H.10 release. A quick look before a decision keeps surprises from feeling like emergencies.
- Expect sharp, short shocks. A one-day drop tied to foreign news is a reason to check your plan, not a reason to rewrite it. Compare the size of the drop to what you can stomach; see What is a Drawdown.
- Keep spreading risk. Mixing regions and asset types limits damage from any one foreign shock. See How to Diversify a Stock Portfolio.
- Keep contributing on schedule. Regular contributions mean you buy through volatile weeks without trying to time them. See What is Dollar-Cost Averaging.
- Learn the fear gauge. Watching the VIX shows when markets are stressed; What is the VIX explains how to read it.
None of this requires trading currencies or guessing the next BOJ move. The goal is understanding why your account might drop on a day when nothing in the US went wrong.