Bybit FX Insight Report: What to Look for in the Yen Carry Trade for 2025

Key Highlights:

• The yen’s role is under scrutiny: While the Japanese yen (JPY) may retain its status as a key funding currency in the near term, Bank of Japan (BoJ) policy shifts and Japan’s economic evolution could diminish its dominance over time.

• Heightened unwinding risks: A stronger yen, driven by BoJ tightening and/or global risk-off events, could trigger rapid carry trade unwinds, leading to increased FX market volatility.

• Emerging alternatives: Funding diversification will become essential, with the Swiss franc (CHF), euro (EUR) and even the U.S. dollar (USD) gaining relevance as funding currencies, depending upon global rate trajectories.

• Strategic adaptation required: Traders will need to adopt dynamic risk management, diversify currency exposure and stay attuned to macroeconomic signals in order to navigate this complex environment.

Historical Context of the Yen Carry Trade

The yen carry trade has been a fundamental strategy in global foreign exchange (FX) markets, rooted in Japan's long-standing, ultra-loose monetary policies. Since the late 1990s, the BoJ has maintained a zero or negative interest rate environment, aiming to combat deflation and stimulate economic growth. This approach has made the JPY an attractive funding currency for investors seeking to borrow at low costs and invest in higher-yielding assets.

Historically, the effectiveness of the yen carry trade has been closely tied to global economic conditions. The carry trade boom from 2004 to 2007 exemplified this dynamic, as investors capitalized on the significant interest rate differentials between the JPY and other currencies. During this period, the U.S. Federal Reserve's aggressive rate hikes created favorable conditions for carry trades, leading to massive capital flows into higher-yielding currencies. 

However, the 2008 global financial crisis marked a turning point. The sudden collapse of overall risk appetite triggered rapid unwinding of carry trades, resulting in a sharp appreciation of the yen. This event underscored the inherent risks of carry trades, particularly in times of financial stress, and highlighted the vulnerability of positions reliant on stable currency conditions.

Figure 1. Data compiled from the Bank of Japan (BoJ), Federal Reserve and IMF, and historical FX market data from Bloomberg Economics and Trading Economics.

The historical performance of the yen carry trade has been cyclical, heavily influenced by global monetary policies and risk sentiment. For instance, the introduction of Abenomics in 2012 revitalized the carry trade environment through aggressive monetary easing and negative interest rates. However, global uncertainties and periodic risk aversion kept investors cautious. As we analyze the current landscape, understanding these historical foundations is crucial, as they provide insights, moving forward, into the potential challenges and opportunities for the yen carry trade.

Current Landscape

Figure 2 Japan Statistics Bureau, Bank of Japan (BoJ) and Ministry of Finance reports on inflation and wage growth trends.

Entering 2025, the landscape for the yen carry trade is undergoing significant transformation. Several macroeconomic factors are reshaping the environment, primarily driven by changes within Japan's economy. Rising inflation, wage growth and speculation regarding shifts in the BoJ's monetary policy are critical developments that investors must navigate.

For years, Japan grappled with deflation and stagnant wage growth. However, post-pandemic recovery has catalyzed a shift, with inflation consistently breaching the BoJ's long-standing 2% target. This inflationary pressure results from various factors, including global supply chain disruptions, rising commodity prices and labor shortages that lead to wage increases. As wages begin to rise, the potential for sustained inflation creates a feedback loop that could support higher consumption and further inflationary pressures.

In light of these economic changes, speculation around potential BoJ policy adjustments is increasing. While the BoJ has historically maintained ultra-loose policies, growing inflationary pressures may prompt the central bank to consider interest rate hikes. The implications of such policy shifts could be profound, affecting not only domestic markets but also global FX dynamics. 

As Japan's economic landscape evolves, the traditional role of the yen as a funding currency is under scrutiny. While the JPY may retain its status in the near term, shifts in monetary policy and economic fundamentals could reshape its appeal for the carry trade.

Moreover, other high-yielding currencies are emerging as attractive alternatives to the yen. The Mexican peso (MXN), South African rand (ZAR) and Turkish lira (TRY) offer compelling carry trade opportunities, bolstered by favorable interest rate differentials. However, these currencies come with their own unique risks. For instance, the MXN is sensitive to U.S. economic cycles, while the ZAR is highly correlated with global commodity prices and domestic political stability. As a result, traders must adopt dynamic risk management strategies and diversify their currency exposure in order to navigate this increasingly complex environment.

Outlook

The outlook for the yen carry trade in 2025 hinges on several critical factors that will shape the future of this strategy. While the yen may continue to serve as a preferred funding currency in the near term, structural shifts in Japan's economic fundamentals and potential BoJ policy adjustments could gradually diminish its dominance.

Key considerations for investors include the likelihood of BoJ rate hikes and the tapering of yield curve control (YCC) measures. If inflation persists and wage growth continues, the BoJ may be compelled to normalize its policies, which could lead to higher Japanese government bond (JGB) yields and have an impact on global bond markets. Such changes would narrow interest rate differentials, affecting the profitability of the yen-funded carry trade.

Additionally, global macroeconomic conditions play a crucial role in determining the viability of carry trades. Diverging monetary policies among major central banks, such as the Federal Reserve and the European Central Bank, will influence interest rate differentials and investor sentiment. As these central banks adjust their policies in response to economic conditions, the relative attractiveness of the yen as a funding currency may diminish, leading traders to explore alternative options.

Figure 3 Data from central bank policy reports (Banxico, SARB, CBRT, BCB, BI), BIS interest rate comparisons and Bloomberg FX carry trade rankings.

Emerging alternatives, such as the CHF and EUR, are gaining relevance in the carry trade landscape. These currencies may offer lower risk profiles and stable funding conditions, especially if their respective central banks maintain accommodative stances while the BoJ tightens its own. The potential for diversification in funding strategies is critical, as it allows traders to mitigate risks associated with reliance on a single currency.

Ultimately, the key to navigating the evolving carry trade landscape in 2025 lies in adaptability. Traders must remain vigilant in monitoring macroeconomic indicators, geopolitical developments and shifts in global risk sentiment. Dynamic risk management strategies, coupled with diversification across multiple high-yielding currencies, will be essential for sustained success.