As market expectations for further interest rate hikes by the Bank of Japan rise, a long-standing "low volatility" trading chain is being re-evaluated: yen carry trade. BCA Research describes it in their latest report as a potential vulnerability in global markets, suggesting that if unwinded, the impact could spill over into stocks, crypto assets, and high-yield credit among various risk segments.
Key Points of the Report: Why "Carry Trade" Could Become a Systemic Risk
The yen carry trade essentially involves borrowing low-interest yen and investing the funds into higher-yielding assets to earn a spread. If the yen suddenly strengthens or financing costs rise, the trade faces dual pressures of "narrowing spread + exchange rate loss," often leading to a chain reaction of unwinding. BCA emphasizes that such positions have expanded significantly in recent years, with a scale that is "hard to quantify precisely but is considerable."
Trigger Conditions: The Triple Resonance of Rate Hike Expectations, Long-term Yields, and Risk Sentiment
The report identifies a more "lethal" combination of risk points: an upward revision of rate hike expectations combined with weakening risk sentiment and a strengthening yen, which makes deleveraging more likely, rather than a change in a single variable. Meanwhile, potential domestic fiscal stimulus and supply pressures in Japan might push up long-term Japanese bond yields and amplify volatility, undermining the stability of carry trades.
(Supplementary Background) Recently, Bank of Japan officials have frequently mentioned the need to "promptly" raise rates to manage inflation risk, further fueling market bets on upcoming tightening.
Historical References: The "Deleveraging Scripts" of 2008, 2015, 2020
The BCA team believes the unwinding of carry trades is not uncommon: in 2008, 2015, and 2020, when global risk appetite cooled rapidly, funds often flowed toward safe-haven assets like the yen, boosting its strength and in turn accelerating unwinding, creating a "mutually reinforcing" negative feedback loop.
Market Position: Yen Has Rebounded, but "Window of Opportunity" May Still Exist
As of now, the yen has risen over 1% against the dollar this year, with the exchange rate fluctuating around 154, a noticeable rebound from previous levels close to 160. Based on this, BCA suggests a strategic inclination: medium to long-term bullish on yen, bearish on dollar. However, the report also warns that if fiscal stimulus briefly boosts risk preference, keeping the yen relatively weak, carry trades may be able to "continue operating," and the real turning point still depends on whether the aforementioned triple conditions materialize simultaneously.
What Traders Are Watching Next
Markets usually look for early signs of "carry trade reversal" across three types of indicators:
- Japanese policy expectations (interest rate path) and long-term Japanese bond yield volatility;
- Changes in the US-Japan interest rate differential and rapid fluctuations of USD/JPY;
- Whether risk assets exhibit synchronized retreats (stocks, crypto, high-yield credit).
