The Yen Carry Trade: Why Japan’s Currency Can Tank the S&P 500

Are you wondering what to do and why the market is selling even with good earnings numbers? This could be one reason...

image with green arrow on YEN and red arrow on USD

If you’ve been watching markets over the past few years, you’ve probably noticed something strange: sometimes the US stock market sells off violently for days or weeks, and the financial media struggles to explain why. Often, the culprit hiding in plain sight is the unwinding of the “yen carry trade.”

Let me break down this powerful market force that most retail investors have never heard of—and why it matters more than ever right now.

What Is the Yen Carry Trade?

The concept is deceptively simple. For decades, Japan has maintained near-zero (or negative) interest rates while the US has had higher rates. This creates an opportunity:

1. Borrow yen cheaply (at 0-0.5% interest)

1. Convert to dollars

1. Buy US assets (Treasuries, stocks, or anything yielding more than your borrowing cost)

1. Pocket the difference

If you borrow at 0.5% and earn 5% on US Treasuries, you’re making 4.5% essentially for free—as long as the yen doesn’t strengthen against the dollar.

This isn’t a small trade. Estimates suggest the global yen carry trade is measured in trillions of dollars. Hedge funds, institutional investors, and even corporations have used this strategy for years.

The Problem: Carry Trades Unwind Violently

Here’s where it gets dangerous for US equity investors.

The carry trade works beautifully when:

• The yen stays weak or weakens further

• US rates stay higher than Japanese rates

• Volatility remains low

But when any of these conditions change, carry traders need to unwind their positions—and they all need to do it at the same time.

The unwind process looks like this:

1. Sell US assets (stocks, bonds, whatever they bought)

1. Convert dollars back to yen

1. Repay the yen loan

When this happens at scale, you get:

• Massive selling pressure on US stocks (supply overwhelms demand)

• The yen strengthening (everyone is buying yen to repay loans)

• A self-reinforcing spiral (as the yen strengthens, more traders need to unwind, creating more selling)

This is why yen carry trade unwinds don’t cause one-day corrections—they cause multi-day or multi-week selling events.

August 2024: A Case Study

Remember the violent selloff in early August 2024? The S&P 500 dropped over 6% in just three trading days. VIX spiked above 65—levels not seen since the COVID crash.

The trigger? The Bank of Japan raised interest rates and hinted at further hikes. Simultaneously, the yen surged from around 162 to 142 against the dollar in a matter of weeks.

Carry traders panicked. The unwind was fast and brutal.

What made it worse: many of these positions were leveraged. When leveraged trades go wrong, margin calls force selling regardless of price—creating cascading liquidations.

Why This Matters Right Now

Several factors are converging that could trigger another carry trade unwind:

1. The Weakening Dollar

The US dollar has been under pressure. A weaker dollar means yen carry traders are seeing their profits erode (or turn into losses) on the currency side of the trade. At some point, the math stops working.

2. Potential Yen Intervention

There’s been increasing speculation about coordinated currency intervention. If the US Treasury (yes, the US Treasury) decides to support a stronger yen—perhaps as part of broader trade negotiations or to reduce trade imbalances—it would be catastrophic for carry traders.

Here’s the thing: the US has historically preferred a strong dollar. But policy priorities can shift. If the administration decides a weaker dollar benefits American exporters and reduces the trade deficit, supporting yen strength could be on the table.

3. Bank of Japan Policy Shifts

The BOJ has been slowly normalizing policy after decades of ultra-loose monetary conditions. Every hint of further rate hikes or reduced bond buying sends tremors through the carry trade.

4. Risk-Off Sentiment

Carry trades only work in calm markets. Any spike in volatility—whether from geopolitics, economic data, or market structure issues—can trigger unwinds. The VIX is the canary in the coal mine.

How to Spot a Carry Trade Unwind

Watch for these signals:

• USD/JPY moving sharply lower (yen strengthening)

• Correlation breakdown: US stocks and bonds selling off together

• Violent moves in the overnight/early morning (when Asian markets are active)

• Selling that persists for multiple sessions without clear fundamental news

• VIX spiking on relatively modest index declines (indicating forced liquidation)

What Can You Do About It?

1. Be aware of the risk. Most selloffs attributed to “recession fears” or “growth concerns” have carry trade dynamics lurking underneath.

1. Watch USD/JPY. Add it to your watchlist. When it’s moving 1-2% per day, pay attention to your equity exposure.

1. Size positions accordingly. Carry trade unwinds create volatility that can blow through stop losses. Position sizing matters more than being “right.”

1. Consider the bounce. Carry trade unwinds are technical, not fundamental. Once the forced selling exhausts itself, markets often snap back violently. The August 2024 low was a generational buying opportunity for those who recognized what was happening.

The Bottom Line

The yen carry trade is one of the largest and most consequential trades in global finance—yet most retail investors have never heard of it. Understanding how it works, and more importantly, how it unwinds, gives you a significant edge in navigating violent market selloffs.

Right now, with the dollar weakening, potential currency intervention on the table, and the Bank of Japan slowly normalizing policy, the conditions for another unwind are quietly building. You don’t need to predict exactly when it will happen. You just need to recognize it when it starts—and respond accordingly.

Stay sharp out there.

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