The global financial markets are experiencing heightened volatility as a significant unwinding of the yen carry trade sends ripples through various asset classes. This widely-used trading strategy, which involves borrowing in low-interest currencies like the Japanese yen to invest in higher-yielding assets, is undergoing a dramatic reversal, catching many investors off guard.
Yen Surge Triggers Market Turbulence
In recent weeks, the Japanese yen has appreciated nearly 7% against the U.S. dollar, causing traders to rapidly unwind their carry trade positions. This shift has led to increased market volatility, particularly across currencies and other financial assets.
Just a month ago, the exchange rate for one U.S. dollar was over 160 yen, the highest in decades. Now, that same dollar is worth only 142 yen, marking a significant decline and the lowest rate since the start of the year.
Analysts Warn of Further Unwinding
Market analysts are closely observing the situation, with some suggesting that the unwinding process is far from over. The carry trade has historically been attractive due to Japan’s negative interest rates and the weakening yen, allowing investors to profit from interest rate differentials and currency appreciation by borrowing yen and investing in higher-yielding assets.
However, this dynamic is rapidly changing. “The Bank of Japan may raise interest rates to as much as 1% in the coming months, while the Federal Reserve is expected to cut rates by 100 basis points this year,” noted Michał Stajniak, Deputy Director of the XTB Analysis Department. These shifts could further complicate the already delicate balance for central banks, particularly the Federal Reserve, which faces the risk of exacerbating market instability with any rate adjustments.
The unwinding of yen carry trades is also reflected in the behavior of yen futures contracts. Short positions in yen futures, which had reached approximately 240,000 contracts, have now contracted to 140,000. Meanwhile, long positions have surged from just a few thousand in 2020 to 65,000.
Swiss Franc Gains as Investors Seek Safe Havens
Amid this turmoil, the Swiss franc has seen significant appreciation as investors turn to safe-haven assets. This has raised concerns among Swiss exporters, who fear that a strong franc could undermine their global competitiveness.
“While the USD/JPY pair has seen the largest number of carry trades, it’s important to note that investors also used the Swiss franc and Chinese yuan in these transactions. The ongoing unwinding of yen carry trades could similarly impact these currencies,” added Stajniak.
As the market grapples with fears of a U.S. recession and ongoing geopolitical tensions, the Swiss franc is increasingly viewed as a safe haven. Analysts from State Street and Citigroup suggest that the franc could replace the yen as the preferred currency for carry trade investors. Although the CHF/JPY currency pair reached multi-year highs of 180.0 earlier this year, it has since corrected to test lows around 170.0.
JPMorgan: Global Carry Trade Unwinding Accelerates
According to a new analysis by JPMorgan Chase & Co., a significant portion of global carry trades—estimated at $200-$250 billion—has been unwound in recent weeks, marking a substantial shift in the financial landscape. Returns across Group-of-10, emerging market, and global carry trade baskets have declined by approximately 10% since May, erasing gains from earlier in the year.
Despite this massive unwinding, JPMorgan strategists warn that the global carry trade strategy now offers limited appeal. “The yield on the carry trade basket has dropped significantly since its 2023 highs, and it no longer provides sufficient compensation for holding emerging market assets through U.S. elections and the risk of further repricing of low-yielding currencies if U.S. yields fall,” explained Meera Chandan, an analyst at JPMorgan.
The consequences of this unwinding extend beyond carry trades themselves, impacting value strategies and realigning foreign exchange rates with interest rate directions.
Understanding the Carry Trade Strategy
In a typical carry trade, an investor borrows Japanese yen at a low interest rate and invests in higher-yielding currencies like the Australian dollar, which offers a higher interest rate. If the exchange rate remains stable, the investor can profit from the difference in interest rates.
However, carry trades carry significant risks. Currency fluctuations, changes in interest rates, and economic or political events can quickly erode profits or lead to losses. Many traders use leverage to amplify potential returns, but this also magnifies the risks. For example, using 20:1 leverage could turn a 3% interest rate differential into a 60% annual return—but losses would be equally amplified.
Carry trades tend to thrive in stable economic environments with clear interest rate differentials, low market volatility, and strong investor risk appetite.
