The end of cheap Japanese money: Goodbye to the carry trade?

Talking about the carry trade may sound highly sophisticated, but its mechanics are straightforward: borrowing where money is cheap and investing where returns are higher. To give an example: if I can borrow funds at 0.5% in yen, I convert those yen into dollars and buy a bond yielding 4%. The difference (after deducting commissions) is my profit.

The risk, however, lies in what is not immediately visible: the exchange rate. If the yen appreciates — that is, if it strengthens — repaying the loan becomes more expensive. And if the Bank of Japan raises interest rates, the funding is no longer as cheap. For this reason, the carry trade tends to thrive when the funding currency remains stable or weakens, and becomes more challenging when that currency strengthens or when the central bank embarks on a tightening cycle.

For years, Japan has been the world’s factory of “cheap money”. Over a number of decades, the country has battled deflation by keeping interest rates extremely low and providing strong support to the bond market. This turned the yen into an ideal currency for financing positions in other markets, from emerging market debt to US equities.

In 2025, however, the script began to change. At the end of January that year, the Bank of Japan set its policy rate at around 0.5%. And on 19 December, it raised it to 0.75%, also signalling that, should its outlook for economic activity and inflation materialise, further rate increases would follow. This normalisation has also been felt in the government bond market, where Japanese government bond yields recorded their largest annual increase since 1994, against a backdrop of reduced bond purchases by the Bank of Japan and expectations of further rate hikes.

What does this mean for the carry trade today? It does not disappear, but it becomes more fragile. At the beginning of 2026, the dollar was trading at around 157 yen, reflecting the fact that the rate differential with the US remains wide (the Federal Reserve maintained a range of 3.50%-3.75% at the end of 2025). That said, a more restrictive policy stance by the Bank of Japan, combined with episodes of uncertainty in global markets (in which the yen is widely regarded as a traditional safe-haven currency) could narrow the carry return as the currency appreciates.

Moreover, the unwinding of the carry trade often has a domino effect: if many investors close positions simultaneously, they sell foreign assets to repay their loans and repurchase yen. This buying pressure pushes the yen higher, further increasing the cost of repayment and potentially forcing others to unwind their positions in turn. There is no need for panic; it is enough for financing to cease being “almost free” for the adjustment to be felt across currencies, equities and credit markets.

Looking ahead to 2026, one of the key variables will be the wage-price dynamic. The Bank of Japan expects inflation to moderate to below 2% in the first half of fiscal year 2026, before picking up again gradually thereafter. At the same time, its surveys show that many companies plan to maintain wage growth in 2026 at levels similar to those seen in 2025. In other words, it is plausible that the Bank of Japan will remain cautious in the short term, but highly dependent on incoming macroeconomic data on prices, growth and wages, in an environment of interest rates that are higher than a few years ago. This reduces the fuel available for the carry trade and increases the likelihood of episodes of volatility as investors reposition.

In short, for many years Japan — both in terms of its currency and its interest rates — has been the “cheapest” source of financing in the global system for the carry trade, but this situation could reverse, marking the end of cheap Japanese money.

_{Diari d’Andorra 11.02.2026}