The yen has been depreciating against the dollar and other currencies for several months. It fell from 100 yen = $0.97 in January 2021 to $0.61 by the end of July 2026 – a fall of 37%. This marked a 40-year low. But then, at the end of July it rallied and by 3 August the rate was 100 yen = $0.64 – a rise of nearly 5%. But why did this happen and what will be the implications for Japan and the wider world economy?
Why has the yen fallen so much since 2021?
There have been two main drivers.
The first is fiscal policy. For many years, Japan has been pursuing expansionary fiscal policy in an attempt to stimulate the sluggish economy. This has led to large budget deficits and public-sector debt. Since 2020, general government gross debt has been around 255% of GDP, the largest of any high-income economy.
Recently, the Japanese government has adopted aggressive supplementary budgets to fund, among other things, fuel subsidies and public-private investment initiatives. This has involved the issuance of more government bonds to fund the necessary borrowing.
Fiscal pressures have also increased becase of demography. A rapidly aging population and declining birth rates have required substantial public spending on healthcare, social security and pensions. Meanwhile, the tax-paying working-age population has declined as a proportion of total population.
On the plus side, unlike most highly indebted nations, over 90% of Japan’s debt is held domestically by Japanese residents, Japanese institutional investors, banks and the Bank of Japan (BoJ). This lowers the risk of default and hence the risk premium on Japanese bonds.
The second driver is monetary policy. Interest rates have been kept low over many years, including periods of negative rates, as the BoJ has attempted to stimulate the economy. Low interest rates have sometimes been backed up with quantitative easing to increase money supply.
Since March 2024, however, there have been four interest rate increases. The latest was in June 2026 when the BoJ raised the short-term policy rate from 0.75% to 1.0% – the highest level since 1995. Despite this, interest rates have remained below those in other countries, and this contributed to the continuing fall of the yen.
A falling yen has helped to increase Japanese exports by making them more competitive, but more expensive imports have contributed to rising Japanese inflation.
Low interest rates have also stimulated the yen-dollar carry trade. This is where investors borrow money in yen at low interest rates, convert it into US dollars and invest it in higher-yielding US assets, typically US government bonds (‘Treasury bonds’). This borrowing in yen to buy dollars further contributed to the depreciation of the yen against the dollar.
Co-ordinated intervention
In an attempt to raise the value of the yen, the Bank of Japan and the US Federal Reserve acted together – their first joint currency rescue operation since 2011. The BoJ spent tens of billions of dollars to buy yen; the US Treasury bought yen by selling euros. Prior to the intervention, global hedge funds held near-record short positions against the yen, meaning that they sold yen at a current price, agreeing to buy them back at a particular later date, hoping that the yen would fall in the meantime and that they would therefore make a profit. The sudden joint intervention forced these traders to buy back the yen to cut their losses before the rate rose further. This accelerated the yen’s appreciation.
But why did the USA join Japan in intervening? Japan is the largest foreign holder of US Treasuries ($1.1 trillion). The USA intervened to discourage Japanese investors from selling US Treasuries in order to raise cash, thereby pushing up US borrowing costs.
The rise in the yen was also encouraged by speculators who are expecting further interest rate rises from the BoJ to counter inflation and support public finances, driving domestic bond yields higher. This will lead to a narrowing of interest rates between Japan and other countries.
Effects on the Japanese economy
If the yen continues to appreciate, this will help to reduce inflation by making imports cheaper and will help to ease cost-of-living pressures on Japanese consumers. Japan is heavily reliant on imported energy and raw materials.
However, the decline in the yen over recent years has provided a large boost to Japanese exports. A sharp reversal in this could severely affect exporters’ profits and have a serious negative impact on economic growth.
If the appreciation continues, it would lead to an unwinding of the carry trade. To prevent mounting currency losses, highly leveraged institutional investors would be forced to sell assets, such as US and other countries’ shares and bonds to buy back yen and pay off their debts. This potentially massive unwinding would be likely to create global market volatility and drive up interest rates.
Articles
- Yen holds gains after Japan, US confirm joint intervention, signal more action
Reuters, Makiko Yamazaki and Leika Kihara (3/8/26)
- Yen surges to three-month peak, dollar pares losses after intervention
Reuters, Chibuike Oguh (3/8/26)
- US dollar weakens sharply against the Japanese yen after officials intervene in markets
ABC7 Eyewitness News, Mayuko Ono and Elaine Kurtenbach (3/8/26)
- Yen hits three-month high after Trump helps prop up currency
The Guardian, Graeme Wearden (3/8/26)
- Why has Trump stepped in to prop up Japan’s currency?
The Guardian, Jonathan Yerushalmy (3/8/26)
- Why the U.S. stepped in after decades to prop up Japan’s yen — and what’s at stake
CNBC, Lee Ying Shan (3/8/26)
- Politics & Policy Analysis: How Bessent is pushing Warsh’s Fed to expand backstop for Japan’s yen defense
CNBC, Matt Peterson (3/8/26)
- Why Japan is propping up the yen – and why the US helped
The Straits Times (4/8/26)
- The Pros and Cons of a Strong Dollar
Johnston Investment Counsel (3/8/26)
- Why the U.S. Stepped In to Prop Up Japan’s Yen Currency
Yahoo!Finance, Tiago Ventura (3/8/26)
- Why the U.S. Is Helping Prop Up Japan’s Weak Currency
The New York Times, Eshe Nelson (3/8/26)
- U.S.-Japan Intervention Triggers Yen Carry Trade Fears
The Chosun Daily, Lee Hai-woon (3/8/26)
- What top minds in markets are saying about the US intervention to prop up Japan’s currency
Business Insider, Jennifer Sor (3/8/26)
Data
Questions
- What have been the benefits and costs to Japan of a depreciating exchange rate?
- Explain the carry trade.
- Why might the yen-dollar carry trade unwind and what would be the consequences for Japan and the USA?
- Find out what has happened to the exchange rate between the yen and the euro. Has this been driven by the carry trade?
- For what reasons might the yen (a) now continue rising; (b) resume depreciating?
- Find out what has happened to the yen/dollar exchange rate since this blog was written. Explain your findings.
A common practice of international investors is to take part in the so-called ‘carry trade’. This involves taking advantage of nominal interest rate differences between countries. For example, assume that interest rates are low in Japan and high in the USA. It is thus profitable to borrow yen in Japan at the low interest rate, exchange it into US dollars and deposit the money at the higher interest rate available in the USA. If there is no change in the exchange rate between the dollar and the yen, the investor makes a profit equal to the difference in the interest rates.
Rather than depositing the money in a US bank account, an alternative is to purchase US bonds or other assets in the USA, where the return is again higher than that in Japan.
If, however, interest-rate differentials narrow, there is the possibility of the carry trade ‘unwinding’. Not only may the carry trade prove unprofitable (or less so), but investors may withdraw their deposits and pay back the loans. This, as we shall, can have adverse consequences on exchange rates.
The problem of an unwinding of the carry trade is not new. It worsened the underlying problems of the financial crisis in 2008. The question today is whether history is about to repeat itself with a new round of unwinding of the carry trade threatening economic growth and recovery around the world.
We start by looking at what happened in 2008.
The carry trade and the 2008 financial crisis
Prior to the financial crisis of 2008, current account deficit countries, such as the UK, USA and Australia, typically had relatively high interest rates, while current account surplus countries such as Japan and Switzerland had relatively low ones. Figure 1 shows central bank interest rates from 2005 to the current day (click here for a PowerPoint).
The carry trade saw investors borrowing money in Japan and Switzerland, exchanging it on the foreign exchange market, with the currency then deposited in the UK, USA and Australia. Hundreds of billions worth of dollars were involved in this carry trade.
If, however, the higher interest rates in the UK and other deficit countries were simply to compensate investors for the risk of currency depreciation, then there would be no excessive inflow of finance. The benefit of the higher interest rate would be offset by a depreciating currency. But the carry trade had the effect of making deficit currencies appreciate, thereby further boosting the carry trade by speculation of further exchange rate rises.
Thus the currencies of deficit countries appreciated, making their goods less competitive and worsening their current account deficit. Between 1996 and 2006, the average current account deficits as a percentage of GDP for Australia, the USA and the UK were close to 4½, 4 and 2, respectively. Between January 1996 and December 2006, the broad-based real exchange rate index of the Australian dollar appreciated by 17%, of the US dollar by 4% and of sterling by some 23%.
Currencies of surplus countries depreciated, making their goods more competitive and further boosting their current account surpluses. For example, between 2004 and 2006 the average current account surpluses as a percentage of GDP for Japan and Switzerland were 3½ and 13, respectively. Their short-term interest rates averaged a mere 0.1% and 1.0% respectively (compared with 3.4%, 4.7% and 5.7% for the USA, the UK and Australia). Yet between January 2004 and December 2006, the real exchange rate index of the yen depreciated by 21%, while that of the Swiss franc depreciated by 6%.
With the credit crunch of 2007/8, the carry trade unwound. Much of the money deposited in the USA had been in highly risky assets, such as sub-prime mortgages. Investors scrambled to sell their assets in the USA, UK and the EU. Loans from Japan and Switzerland were repaid and these countries, seen as ‘safe havens’, attracted deposits. The currencies of deficit countries, such as the UK and USA, began to depreciate and those of surplus countries, such as Japan and Switzerland, began to appreciate. Between September 2007 and September 2008, the real exchange rate indices of the US dollar and sterling depreciated by 2% and 13% respectively; the yen and the Swiss franc appreciated by 3% and 2¾%.
This represented a ‘double whammy’ for Japanese exporters. Not only did its currency appreciate, making its exports more expensive in dollars, euros, pounds, etc., but the global recession saw consumers around the world buying less. As a result, the Japanese economy suffered the worst recession of the G7 economies.
The carry trade in recent months
Since 2016, there has been a re-emergence of the carry trade as the Fed began raising interest rates while the Bank of Japan kept rates at the ultra low level of –0.1% (see Figure 1). The process slowed down when the USA lowered interest rates in 2020 in response to the pandemic and fears of recession. But when the USA, the EU and the UK began raising rates at the beginning of 2022 in response to global inflationary pressures, while Japan kept its main rate at –0.1%, so the carry trade resumed in earnest. Cross-border loans originating in Japan (not all of it from the carry trade) had risen to ¥157tn ($1tn) by March 2024 – a rise of 21% from 2021.
The process boosted US stock markets and contributed to the dollar appreciating against the yen (see Figure 2: click here for a PowerPoint).
Although this depreciation of the yen helped Japanese exports, it also led to rising prices. Japanese inflation rose steadily throughout 2022. In the 12 months to January 2022 the inflation rate was 0.5% (having been negative from October 2020 to August 2021). By January 2023, the annual rate had risen to 4.3% – a rate not seen since 1981. The Bank of Japan was cautious about raising interest rates to suppress this inflation, however, for fear of damaging growth and causing the exchange rate to appreciate and thereby damaging exports. Indeed, quarterly economic growth fell from 1.3% in 2023 Q1 to –1.0% in 2023 Q3.
But then, with growth rebounding and the yen depreciating further, in March 2024 the Bank of Japan decided to raise its key rate from –0.1% to 0.1%. This initially had the effect of stabilising the exchange rate. But then with the yen depreciating further and inflation rising from 2.5% to 2.8% in May and staying at this level in June, the Bank of Japan increased the key rate again at the end of July – this time to 0.25% – and there were expectations that there would be another rise before the end of the year.
At the same time, there were expectations that the Fed would soon lower its main rate (the Federal Funds Rate) from its level of 5.33%. The ECB and the Bank of England had already begun lowering their main rates in response to lower inflation. The carry trade rapidly unwound. Investors sold US, EU and UK assets and began repaying yen loans.
The result was a rapid appreciation of the yen as Figure 3 shows (click here for a PowerPoint). Between 31 July (the date the Bank of Japan raised interest rates the second time) and 5 August, the dollar depreciated against the yen from ¥150.4 to ¥142.7. In other words, the value of 100 yen appreciated from $0.66 to $0.70 – an appreciation of the yen of 6.1%.
Fears about the unwinding of the carry trade led to falls in stock markets around the world. Not only were investors selling shares to pay back the loans, but fears of the continuing process put further downward pressure on shares. From 31 July to 5 August, the US S&P 500 fell by 6.1% and the tech-heavy Nasdaq by 8.0%.
As far as the Tokyo stock market was concerned, the appreciation of the yen sparked fears that the large Japanese export sector would be damaged. Investors rushed to sell shares. Between 31 July and 5 August, the Nikkei 225 (the main Japanese stock market index) fell by 19.5% – its biggest short-term fall ever (see Figure 4: click here for a PowerPoint).
Although the yen has since depreciated slightly (a rise in the yen/dollar rate) and stock markets have recovered somewhat, expectations of many investors are that the unwinding of the yen carry trade has some way to go. This could result in a further appreciation of the yen from current levels of around ¥100 = $0.67 to around $0.86 in a couple of years’ time.
There are also fears about the carry trade in the Chinese currency, the yuan. Some $500 billion of foreign currency holdings have been acquired with yuan since 2022. As with the Japanese carry trade, this has been encouraged by low Chinese interest rates and a depreciating yuan. Not only are Chinese companies investing abroad, but foreign companies operating in China have been using their yuan earnings from their Chinese operations to invest abroad rather than in China. The Chinese carry trade, however, has been restricted by the limited convertibility of the yuan. If the Chinese carry trade begins to unwind when the Chinese economy begins to recover and interest rates begin to rise, the effect will probably be more limited than with the yen.
Articles
- A popular trading strategy just blew up in investors’ faces
CNN, Allison Morrow (7/8/24)
- The big ‘carry trade’ unwind is far from over, strategists warn
CNBC, Sam Meredith (13/8/24)
- Unwinding of yen ‘carry trade’ still threatens markets, say analysts
Financial Times, Leo Lewis and David Keohane (7/8/24)
- The yen carry trade sell-off marks a step change in the business cycle
Financial Times, John Plender (10/8/24)
- Forbes Money Markets Global Markets React To The Japanese Yen Carry Trade Unwind
Forbes, Frank Holmes (12/8/24)
- 7 unwinding carry trades that crashed the markets
Alt21 (26/1/23)
- A carry crash also kicked off the global financial crisis 17 years ago — here’s why it’s unlikely to get as bad this time
The Conversation, Charles Read (9/8/24)
- What is the Chinese yuan carry trade and how is it different from the yen’s?
Reuters, Winni Zhou and Summer Zhen (13/8/24)
- Carry Trade That Blew Up Markets Is Attracting Hedge Funds Again
Yahoo Finance/Bloomberg, David Finnerty and Ruth Carson (16/8/24)
- Currency Carry Trades 101
Investopedia, Kathy Lien (9/8/24)
- Carry Trades Torpedoed The Market. They’re Still Everywhere.
Finimize, Stéphane Renevier (13/8/24)
Questions
- What factors drive the currency carry trade?
- Is the carry trade a form of arbitrage?
- Find out and explain what has happened to the Japanese yen since this blog was written.
- Find out and explain some other examples of carry trades.
- Why are expectations so important in determining the extent and timing of the unwinding of carry trades?
The European Central Bank does not provide direct support to eurozone countries by buying new bonds. However, it can give indirect support by helping banks buy such bonds. In a move announced on 8 December, the ECB will increase the maximum term of its ‘longer-term refinancing operations’ (LTROs) from the current 13 months to three years. In other words, it will effectively provide three-year loans to banks by purchasing banks’ assets on a ‘repurchase (repo)’ basis, whereby banks agree to buy back the assets at the end of the three-year term.
The hope is that banks will use these loans (at an annual rate of 1%) to purchase new bonds from countries such as Italy and Spain. If banks are more willing to buy them, this should help reduce the interest rate at which governments are forced to borrow. Banks would benefit from the ‘carry trade’, whereby they borrow at a low interest rate (from the ECB) and lend at a higher rate to governments by buying their bonds.
To encourage banks to take advantage of these new longer-term repos,the ECB announced that the assets it was prepared to purchase would include securitised assets with a rating of single A (the highest rating is AAA). In other words, it would accept assets with a ‘second-best rating’.
But although the scheme would allow banks to make a clear gain from a carry trade, banks may be reluctant to use such loans to increase their holdings of sovereign debt of countries with large debt to GDP ratios, given concerns in the market about the riskiness of such assets.
Articles and podcast
ECB repo extension a fillip for sovereigns Financial News, Matt Turner (15/12/11)
Doubts over ECB move to boost bond sales Financial Times, Tracy Alloway (15/12/11)
ECB Chief Plays Down Hopes for Bigger Bond Purchases Wall Street Journal, Tom Fairless And Margit Feher (15/12/11)
Eurozone crisis ‘misdiagnosed’ BBC Today Programme, George Magnus (16/12/11) (second part of podcast)
Banks snap up €500bn in loans from European Central Bank Guardian. Larry Elliott (22/12/11)
Analysis: ECB cash to give indirect boost via banks Reuters, Natsuko Waki and Steve Slater (22/12/11)
Demand for ECB loans rises to €489bn Financial Times, Tracy Alloway and Ralph Atkins (21/12/11)
ECB’s rescue of eurozone banks is temporary BBC News, Robert Peston (21/12/11)
ECB Press release
ECB announces measures to support bank lending and money market activity ECB (8/12/11)
Questions
- Explain how repos work. What is the difference between repos and reverse repos?
- What is meant by the term ‘carry trade’?
- Why may banks be unwilling to gain from the carry trade possibilities of the ECB’s new 3-year LTROs by using them to fund the purchase of new sovereign bonds? What risks are entailed by their doing so?
- How do these new long-term repo operations differ from quantitative easing? Explain whether or not the effect is likely to be similar
- What are the arguments for and against the ECB engaging in a round of substantial quantitative easing?
For the past three years the Japanese yen has been appreciating against the US dollar and many other currencies. From the end of June 2007 to 14 September 2010, the yen appreciated from ¥100 = $0.81 to ¥100 = $1.20 (a 48% appreciation). Over the same period the yen exchange rate index rose from 113.3 to 172.4 (a 52% appreciation). The rising yen has been impeding Japan’s recovery as it has made its exports more expensive, while, at the same time, making imports cheaper and thus making it harder for domestic firms to compete.
Until 14 September 2010, the yen was freely floating. But on 15 September, the Japanese central bank decided to intervene by selling yen and buying dollars and other currencies.
But why had the yen risen so strongly? There are four main reasons.
The first is the persistent Japanese trade surpluses, partly stimulated by falling costs of production in Japan.
The second is the unwinding of the carry trade. Before the banking crisis of 2007/8, many banks and other financial institutions borrowed yen, given the low interest rates in Japan, and used the yen to purchase dollars and pounds, given the much higher interest rates in the USA and the UK. The effect of this ‘carry trade’, as it was known, was to drive up the exchange rates of the dollar and sterling and drive down the value of the yen. This encouraged further speculation as people sold yen in anticipation of further depreciation and purchased dollars and sterling in anticipation of further appreciation. With the banking crisis, however, short-term financial flows decreased and the current account became more important in determining exchange rates. The carry trade began to unwind and people began selling dollars and sterling and buying yen. What is more, towards the end of 2008, interest rates were reduced substantially in the USA and the UK in order to stimulate aggregate demand. The interest rate differential between Japan and the USA and UK virtually disappeared. This further encouraged the purchase of yen and the sale of dollars and sterling as carry trade investors began paying back their loans to Japan.The third reason for the appreciation of the yen is the actions of the Chinese who have used their surpluses to buy other currencies: originally mainly dollars, but increasingly yen.
The fourth reason is speculation. As the yen has risen, so increasingly people have bought yen in anticipation of further appreciation. But, of course, this speculation has brought about the very effect the speculators anticipated. Such speculation can be very powerful, given that some $4 trillion goes across the foreign exchange markets every day (see The inexorable growth of FOREX).
So will the intervention by the Bank of Japan be successful in causing the yen to depreciate? Or will the forces that drove up the yen prove impossible to resist? The following articles consider this question and also look at the factors that caused the yen to appreciate and its effects on the Japanese economy.
Articles
Japan’s $21b move to weaken yen may be futile Sydney Morning Herald (16/9/10)
Japan acts to weaken surging yen Guardian, Larry Elliott and Graeme Wearden (15/9/10)
Q+A: How is Japan judging success in yen intervention? Reuters, Hideyuki Sano and Charlotte Cooper (17/9/10)
Tokyo action puts brake on yen Financial Times, Peter Garnham (17/9/10)
It’s hard to keep a strong yen down CTV, Canada, Brian Milner (16/9/10)
Firm stance on yen stressed / Govt, BOJ strike decisive pose, but drastic action still required Daily Yomiuri, Japan, Tadashi Isozumi and Yomiuri Shimbun (16/9/10)
Bernanke Shadow of Easing Limits BOJ Success With Yen Weakness Bloomberg, Ron Harui and Joshua Zumbrun (17/9/10)
The Bank Of Japan Is Spitting In The Wind Wall Street Journal blogs: The Source, Nicholas Hastings (16/9/10)
Japan intervenes in markets to combat rising yen BBC News, Mariko Oi (15/9/10)
Q&A: What’s moving the Japanese yen? BBC News (15/9/10)
Currency intervention’s mixed record of success BBC News, Russell Hotten (16/9/10)
Yen intervention: Because I Kan The Economist (16/9/10)
Beggar, then sneakily enrich, thy neighbour The Economist (15/9/10)
The yen and gold The Economist, Buttonwood (15/9/10)
Data
Dollar/yen exchange rate X-rates.com
Statistical Interactive Database – interest and exchange rates data Bank of England
Currencies BBC News
Currency converter Yahoo Finance
Questions
- Why has the Japanese yen appreciated so much over the past three years?
- What will be the effect of the Bank of Japan’s exchange market intervention on Japanese money supply? What will determine the size of this effect?
- Why might the Bank of Japan’s actions have been influenced by the anticipation of further quantitative easing by the US Federal Reserve Bank?
- What factors determine the likely success of foreign exchange market intervention by central banks?
- What will determine how speculators will react to the Bank of Japan’s actions?
- Discuss the following quote from the second The Economist article above: “A bit of inflation in Japan wouldn’t just be a good thing. It would be a really, really great thing. And if other countries react to Japan’s intervention by attempting to print and sell their own currencies in order to toss the deflationary potato to someone else, well then so much the better.”
- If all countries seek to achieve export-led growth, is this a zero-sum game?
- Why has the price of gold been rising?