The Yen Carry Trade Unwind: A Looming Financial Shock and the Opportunity It Presents

There’s something stirring beneath the surface of the global financial system. You can’t see it in the headlines. You won’t find it on your CommSec homepage. But it’s there—quiet, monstrous, and ready to burst.

And when it does?

It could trigger the most devastating financial event of this century. Bigger than COVID. Bigger than the GFC. We’re talking full-blown Great Depression territory.

That might sound dramatic. But stick with me because this isn’t doomsaying. It’s pattern recognition. It’s history rhyming. It’s spotting the rickety scaffolding propping up the global economy—and understanding what happens when the wind picks up.

This story isn’t about inflation or AI or bond yields or Biden or Trump.

This is about a trade. One trade. A trade so big, so lopsided, and so globally entangled that it could ripple through every asset class on Earth.

It’s called the yen carry trade.

You probably don’t think about it much—if you’ve ever even heard of it. But it’s one of the foundational forces behind modern markets. And it’s starting to wobble.

Before we dive into how it works, how it could unwind, and how you might actually profit from it, let’s start by setting the mood. Because this movie has already been made before. We know how it ends. Let’s talk about the prequel...

George Soros and the Collapse of the Pound: Lessons from a Legendary Currency Crisis

Let’s take a trip back to 1992.

George Soros—the man, the myth, the market predator—spotted a massive disconnect between political fantasy and economic reality.

The UK had joined the European Exchange Rate Mechanism (ERM), pegging the British pound to the Deutsche Mark. Politicians loved it—stability! European unity! Confidence!

But, the economic data told a different story. The UK was in a recession. Inflation was high. Unemployment was spiking. Maintaining the peg meant raising interest rates... which would make everything worse.

Soros saw it. He realised the Bank of England was trying to defend the indefensible. So, he bet against them. Hard.

He shorted the pound to the tune of $10 billion, borrowing it and converting it to other currencies, knowing full well that when the Bank of England gave up and let the pound fall, he’d make a killing.

And he did. £3.3 billion in profit, to be exact. In one of the most legendary trades of all time, Soros became ‘The Man Who Broke the Bank of England.’

Why?

Because when a central bank’s policies don’t match economic reality, the market will eat them alive.

That’s not hyperbole. That’s the playbook.

And today, the Bank of Japan is walking straight into the same trap—only this time, the stakes are way higher.

We’ve seen this movie before. Again and again.

Every major crash starts the same way: a belief system, baked into policy, that’s out of touch with reality.

In the 1600s, it was tulips. In the 2000s, it was subprime mortgages. In 2022, it was ‘tech stocks can only go up.’

And now?

It’s this idea that Japan can keep its interest rates at zero forever without consequence. That the yen can be an endless source of free liquidity for the world. That inflation will never really take hold in Japan.

That fantasy is the bedrock of the yen carry trade, and it’s the most crowded trade in history. Yes, even more than tech stocks in 1999. This thing is systemic.

Let’s break it down.

What Is the Yen Carry Trade and How Does It Work?

The yen carry trade is one of those genius little bits of financial engineering that seems harmless until it goes nuclear.

Over the past two decades, the Bank of Japan (BOJ) has maintained interest rates at or below zero. This has made Japan a haven of stagnation, subdued inflation, and extraordinarily cheap capital. In effect, the BOJ turned the yen into the cheapest major currency in the world to borrow.

Taking advantage of this, global investors have routinely borrowed yen at negligible cost, then converted it into other currencies to chase higher-yielding assets abroad. These assets span a broad spectrum—from US Treasuries and Australian government bonds to European property, emerging market debt, and the ever-volatile tech stocks of Wall Street.

The mechanics of the trade are elegantly simple: borrow yen at close to 0%, invest in something yielding 4%, 6%, or even 10%, and pocket the difference. This profit margin is what traders call the “carry.” When the yen weakens further, which it often does due to Japan’s dovish monetary stance, it adds an extra layer of gain through favourable currency moves.

But there’s a catch. The entire structure rests on one key assumption: that Japanese interest rates will remain ultra-low indefinitely. And that assumption is now under threat.

Why the Yen Carry Trade Is Under Threat in 2025

So what’s changed?

A lot. And fast.

After decades of fighting deflation, Japan is finally seeing real inflation. Consumer prices are rising. Wages are ticking up. Corporate Japan is adjusting. The country is changing.

Meanwhile, the rest of the world has spent the past two years raising interest rates to fight inflation. The US Fed went from 0% to over 5%. The RBA, ECB, Bank of Canada—they all hiked aggressively.

This created a massive interest rate gap. Borrowing in yen and investing elsewhere was insanely profitable. So, the carry trade ballooned.

But now? That gap is narrowing. The Fed is cutting rates. The ECB is slowing down. And the Bank of Japan is starting to blink. They’ve already abandoned Yield Curve Control, loosened some policy language, and are preparing the market for hikes.

It doesn’t take much. Even a tiny 0.25% hike from the BOJ could tip the first domino. Suddenly, the 'borrow-yen-invest-elsewhere' trade doesn’t look so smart.

If the yen strengthens sharply, those trades go underwater fast. Billions in positions need to be unwound. And that’s when the real fun starts.

One of the key relationships to watch is the gap between the 10-year yields in the US and Japan, as shown below.

Monthly chart of the US 10-year yield in red and the Japanese 10-year yield in blue (Source: TradingView)

How a Stronger Yen Could Trigger a Global Financial Crisis

Here’s how the vicious cycle unfolds, step by brutal step.

It begins when the Bank of Japan raises interest rates—or when Japanese inflation spikes hard enough to make the market believe a hike is imminent. Either development signals the beginning of the end for the ultra-loose monetary policy that has underpinned the yen carry trade for decades.

As soon as that signal hits, the yen starts to strengthen—fast. A rising yen means that all those investors who borrowed in yen to buy foreign assets—US bonds, emerging market debt, high-growth equities—now face mounting costs to repay those loans. What once seemed like free money turns into a trap. Profits vanish, and losses begin to bite.

Initially, the reaction is orderly. A few cautious investors begin to unwind their trades, selling off the foreign assets they bought and buying back yen to settle their positions. But here’s the problem: buying yen drives its value up even more. That rising yen makes it even more expensive for the next cohort of investors to close their positions.

Soon, the trickle turns into a flood. The currency’s strength accelerates, compounding losses across portfolios. Panic sets in. Fund managers begin to sell risk assets en masse, from US tech to Turkish bonds. Liquidity thins out. Correlations go to one. Forced selling spreads like wildfire.

And just like that, what began as a routine shift in monetary stance becomes a full-blown, self-reinforcing feedback loop. Each wave of yen appreciation triggers more position unwinds, which drives the yen higher, which leads to more selling, and so on. It’s a doom loop—and once it begins, it’s incredibly hard to stop. It’s a classic self-feeding cycle—like a snake eating its own tail, only it’s biting harder each time.

The more people unwind, the worse it gets for everyone still in the trade. Liquidity vanishes. Correlations go to one. Margin calls get triggered.

This isn’t just a Japan story. This is a global deleveraging event in disguise.

Now, we aren't saying all of this is a foregone certainty. This is just one potential scenario. Things still need to fall into place for the events to trigger this way. But the ramifications if it does happen are massive. So it's worth paying attention.

Japanese yen futures monthly chart (Source: TradingView)

What Could Trigger or Prevent the Yen Carry Trade Collapse?

Several events could trigger an accelerated unwind of the yen carry trade. A surprise interest rate hike by the Bank of Japan would be the most direct catalyst, especially if inflation data forces their hand. A sudden surge in Japanese consumer prices or wage growth beyond expectations would spook markets into pricing in tighter policy. Similarly, a broad shift in global risk appetite—due to war, banking crises, or political upheaval—could also prompt a flight to safety, sparking a wave of yen buying.

Another possibility is a fund-level failure. If a large macro hedge fund or insurance firm is caught too deep in carry trades and begins liquidating, the chain reaction could start there.

On the flip side, several factors could delay the unwind. The BOJ might continue to jawbone markets—talking hawkish without taking concrete steps. Global inflation might drop faster than expected, narrowing rate differentials. And Japan could intervene directly in foreign exchange markets, although history suggests this kind of intervention rarely works for long.

The current Trump tariff war could also complicate matters. It’s hard to predict where inflation will strike the hardest, but markets currently expect the heaviest impacts on the US. That could force up US rates far above any move in Japan, effectively drowning out the impact of Japanese inflation.

There are many moving parts.

But, the key point is this: the trade is not built to survive volatility. The entire structure is a volatility suppression machine. When that suppression ends, the resulting pendulum swing tends to overshoot. And that’s where the damage is done.

How to Spot the Yen Carry Trade Unwind in Real Time

If you want to spot the early tremors of this unfolding crisis, there are several key indicators to watch. First, keep an eye on the USD/JPY exchange rate. If this pair starts collapsing—dropping rapidly and without clear fundamental justification—that’s your flashing red light. It signals that the yen is strengthening suddenly, likely due to carry trades being unwound en masse.

Another key signal lies in Japanese bond yields. If they begin to spike aggressively, it's a sign that the Bank of Japan is losing control of the bond market—a precursor to a broader monetary tightening that could rattle the entire carry trade structure.

Volatility indexes are another canary in the coal mine. Watch the VIX and MOVE indexes closely. A sharp spike in either suggests fear is returning to markets, and that investors are pricing in the kind of dislocation that typically accompanies systemic deleveraging events.

Unexplained or sudden liquidations in US equities or emerging market bonds are also red flags. These markets are among the most popular destinations for carry trade capital. If they start falling apart, especially without a clear domestic catalyst, it's likely tied to yen-related unwinds.

And finally, if you start seeing Bloomberg or Reuters headlines quoting unnamed hedge fund sources in full-blown panic mode—that's usually a sign that the avalanche has already begun.

This won’t be a gentle correction or a slow unwind. It will move fast—days, maybe even hours. By the time the mainstream financial media catches up, the bulk of the damage will already be done.

Ways Traders Might Play the Collapse of the Yen Carry Trade

Despite all the doom and gloom, this is where the upside lies. For traders who are alert, strategic, and early, a breakdown of the yen carry trade could deliver some of the most asymmetric opportunities of the decade.

Positioning for a stronger yen is the most obvious approach. Traders might do this by shorting USD/JPY or going long the yen via FX options or futures. Once the reversal starts, the currency move could be swift and brutal. Traders with call options on the yen stand to benefit from explosive upside if it plays out.

Another strategy is to get long volatility. That means buying VIX calls, using volatility ETFs, or positioning in tail-risk funds designed to spike during market stress. Carry unwinds are volatility events—if this happens, VIX is going up.

Traders might also look to short, riskier asset classes that have benefitted most from yen-funded inflows. Think emerging market debt, speculative tech, or highly leveraged corporates.

Alternatively, there is playing defence. Long on gold, short-duration sovereigns, or high-quality balance sheet stocks. Keep an eye on Japanese domestic equities—ironically, a stronger yen might actually help companies that rely on imports or benefit from increased domestic purchasing power.

Those who will win big IF this trade does unwind violently will be those who are prepared but not panicked. When everyone else is forced to sell, those with dry powder can buy generational opportunities.

The goal here isn’t to be a doom prophet. It’s to identify one possible scenario so that we can identify it early if it plays out and position accordingly.

Why the Yen Carry Trade Unwind Could Be a Good Thing

Let’s be real: financial systems break all the time. LTCM. Dot-com. GFC. COVID.

And every time, investors say, “Nobody could have seen it coming.”

Except... some people did.

Some traders are looking at this unwind, and some have been watching it closely for many years.

The yen carry trade unwind is visible in real time. You just have to know where to look. The warning lights are flashing. The gears are grinding. And the narrative is turning.

But here's the hopeful bit: if you understand what’s happening—if you prepare, hedge, watch the signs—this isn’t a catastrophe. It’s the cleansing fire that resets global markets. That flushes excess leverage. That creates generational buying opportunities in assets that actually make sense.

So don’t fear it. Embrace it.

Because when this monster stirs, the world will change.

And if you’re ready, you won’t just survive it.

You’ll thrive.