The End of the Weak Yen and BOJ Policy Shift: Ripple Effects of the Carry Trade Collapse [EN]

"The Bank of Japan's normalization is a true dawn. However, no one yet knows how violent a sunrise that dawn will bring to global markets."

 Hajime Takata, BOJ Policy Board Member (February 2026)

 

[Prologue: The Market Observer's Perspective]

Thirty years is enough to shape an entire generation. For many global investors born and raised after 1995, 'Japan' and 'zero interest rates' were synonymous. The yen was the cheapest currency to borrow in the world, and the yen carry trade—borrowing it to invest in high-yield assets globally—was one of the oldest and largest investment strategies on the planet. This structure began to shake in 2024 and entered a phase of dismantling through 2025 and 2026.

What this observer focuses on is not the change in interest rate figures, but the depth of the structural shift those numbers imply. On August 5, 2024, a single BOJ rate hike collapsed the Nikkei by 12.4%, dragged down the Nasdaq, and plummeted Bitcoin by 20% in just 24 hours. On January 20, 2026, the 40-year Japanese Government Bond (JGB) yield breached 4.24%, pulling the US 30-year Treasury yield up with it. A world where a spasm in the Tokyo bond market shakes the pulse of the New York stock market—this is the reality of the financial structure we currently live in. The core question this report tracks is singular: To what depth is the normalization of Japanese monetary policy an internalized risk within the global financial system?

EXECUTIVE SUMMARY

The Bank of Japan (BOJ) raised its policy rate consecutively to 0.5% in January 2025 and 0.75% in December 2025, reaching its highest level since 1995. While it remains at 0.75% as of March 2026, market consensus anticipates further hikes reaching 1.0~1.25% by 2027.^¹ Simultaneously, Prime Minister Sanae Takaichi's massive fiscal expansion policy pushed ultra-long JGB yields to 30-year highs, with the 40-year yield breaking 4% for the first time in history to hit 4.24% on January 20, 2026.^² This dual shock—the collision of monetary tightening and fiscal expansion—is accelerating the structural dismantling of the 'yen carry trade,' which has served as global finance's cheap funding source for decades, and its unwinding process is repeatedly manifesting as unpredictable global liquidity shocks.

01. Structure of the BOJ Policy Shift: Escape After 30 Years

From Negative Rates to 0.75%: The Trajectory of Normalization

The BOJ's policy shift began in March 2024 with the end of negative interest rates (-0.1%) and the abolition of Yield Curve Control (YCC). This was followed by phased hikes to 0.25% in July 2024, 0.5% in January 2025, and 0.75% in December 2025. The December 2025 hike was a unanimous decision by the BOJ Policy Board, converging into consensus the tension from the previous two meetings where two members had already voted for a hike.^³ At the March 2026 meeting, the board decided to hold rates in an 8-to-1 vote, though dissenting member Takata immediately called for a hike to 1.0%.^⁴

The core variable that enabled this normalization was wages. In the 2025 Shunto (spring wage offensive) negotiations, the overall wage increase rate (including seniority) hit 5.32%, and the base pay increase rate reached 3.75%, marking a 33-year high.^⁵ The BOJ's assessment that a virtuous wage-price spiral had begun functioning provided the logical foundation for the rate hikes. With the 2026 Shunto projecting an overall increase of 5.0% and a base pay increase of 3.4%, the upward wage trend is expected to continue.^⁵

Exceeding the Inflation Target for 4 Consecutive Years: Structural Entrenchment of Inflation

According to the BOJ, Japan's inflation is projected to exceed the 2% target for the fourth consecutive year across the 2025-2026 fiscal years. The baseline scenario envisions it starting at around 4% in early 2025, gradually declining to the 3% level in the second half, and converging around 2.1% in early 2026.^⁶ The core CPI (excluding fresh food) forecast for fiscal 2025 is 2.7%, and it is expected to stabilize at the 2% target level in 2027.^⁷ In particular, cost-push pressures, such as grocery prices including rice surging at an annualized rate of 71%, are supporting the inflation structure from the bottom up.^⁸

02. The Structure of Yen Weakness: Why the Yen Remains Weak Even After Rate Hikes

The Dual Gravity of the Interest Rate Gap and Fiscal Concerns

Typically, a rate hike induces currency strength. However, a paradox emerged where the yen actually depreciated by 1.1% against the dollar even after the BOJ raised rates to 0.75% in December 2025.^³ The causes of this paradox are twofold. First, the BOJ's real interest rate remains deeply negative. Subtracting an inflation rate of roughly 3% from the nominal policy rate of 0.75% leaves the real interest rate at over -2%. In other words, 0.75% is merely "less accommodative," not tight. Second, market concerns over the Takaichi cabinet's fiscal expansion are continuously pressuring the yen. In January 2026, the Japanese yen traded at the 156-159 yen per dollar level, approaching the 160-yen mark where authorities had intervened directly in the FX market in 2024.^⁹

The Collision of Fiscal Expansion and Monetary Tightening: Takaichi's Dilemma

During the LDP presidential election, Prime Minister Takaichi strongly opposed rate hikes, though she softened her stance after taking office. However, her economic policy line is a continuation of Abenomics. In November 2025, the cabinet confirmed a comprehensive economic package exceeding 20 trillion yen, and the FY2026 budget was compiled at a record scale exceeding 122 trillion yen.^¹⁰ The IMF's 2025 Article IV report on Japan projected that Japan's fiscal deficit-to-GDP ratio would slightly increase to 2.7% in 2025, warning that debt sustainability could be threatened without a clear fiscal consolidation plan.^¹¹

03. The JGB Rebellion: The Bond Market Judges Fiscal Policy

January 20, 2026: Anatomy of an Historic Bond Plunge

January 20, 2026, is a day that will be recorded in the history of the Japanese bond market. Prime Minister Takaichi's declaration of a snap election and the announcement of a 21.3 trillion yen stimulus package (including a temporary two-year exemption of the 8% consumption tax on food) triggered a selling storm in the bond market. On this day, the 40-year JGB yield broke 4.24%, renewing its all-time high since the maturity was introduced in 2007, while the 30-year yield surged 25-30 bps in a single session, marking its largest daily fluctuation since 1999.^²

The global transmission of the shock was immediate. Right after the JGB plunge, the US 10-year Treasury yield spiked by 6 bps, and the 30-year yield approached the psychological threshold of 5%. The mechanism was the unwinding of the yen carry trade. As Japanese life insurers recorded valuation losses of roughly 9 trillion yen (about $60 billion) in their domestic bond portfolios, they began selling overseas assets (US/European government bonds and equities) to cover domestic obligations. The overseas asset holdings of the Japanese life insurance sector, including Dai-ichi Life and Nippon Life, are estimated to reach $5 trillion.^²

Structural Rise in Bond Yields: Post-YCC Collapse

Since the abolition of YCC in March 2024, JGB yields have been repriced according to market principles. The 10-year yield hit 2.019% in December 2025, the highest since 2007, and the 30-year yield reached 3.45%, the highest since 1999.^¹² This yield spike stems from dual pressures. While the BOJ's quantitative tightening (QT) is underway, massive additional JGB issuance by the Takaichi cabinet is shaking the supply-demand balance. In December 2025, Japanese life insurers net-sold 822.4 billion yen worth of bonds with maturities over 10 years, recording the largest sell-off since Bloomberg began tracking the data.^¹³

04. Structure and Unwinding Mechanism of the Yen Carry Trade

The World's Largest Quiet Leverage

The yen carry trade is not merely a speculative strategy. According to BIS estimates, as of March 2024, offshore yen-denominated bank claims on the non-bank sector exceeded 80 trillion yen (about $500 billion), suggesting the scale of leverage structurally embedded in the global financial system.^¹⁴ The basic structure of the strategy is simple. If one borrows yen at a 0.1-0.5% interest rate and invests in US Treasuries (5.5%) or emerging market assets, profits equal to the interest rate differential are automatically generated as long as the exchange rate remains stable. Up until mid-2024, the weak yen, which fluctuated around 161 yen per dollar, added foreign exchange gains to this strategy.

August 5, 2024: Anatomy of the Unwind

On July 31, 2024, when the BOJ raised rates from 0.1% to 0.25%, a chain liquidation occurred in just five days. The USD/JPY exchange rate appreciated 12% from 161 to 142 yen, and the Nikkei plunged 12.4% in a single trading day, recording its largest drop since 1987. The S&P 500 also fell 3% on the same day, and Bitcoin and Ethereum plummeted by up to 20%.^¹⁵ According to a post-mortem analysis by the BIS, unlike typical carry trade unwinds, the shock was concentrated in US momentum stocks (Nasdaq Big Tech). This is because Japanese institutional investors first disposed of the assets with the largest valuation gains: US growth stocks. According to Wellington Management's analysis, Japanese investors shifted to hedging their US Treasury exposure rather than selling outright, while directly selling equities; this difference explains the anomalous phenomenon where US Treasury yields actually fell at the time.^¹⁶

05. Global Ripple Effects: The Seismic Shift of Capital Reallocation

The Return of Japanese Capital: The $7 Trillion Problem

Japan is the world's largest net creditor nation. Backed by current account surpluses accumulated over decades, Japanese institutional investors have been a major buying force for US Treasuries and European bonds. With JGB yields structurally rising, a 'repatriation' trend is strengthening, where a portion of this capital is returning home after the sale of overseas assets. According to European Business Magazine, the potential capital that could flow from Japanese savings into global markets is estimated at $7 trillion, and this is being pinpointed as the single largest risk factor in the global reallocation of capital.^²

The Link to the US Treasury Market

The surge in Japanese government bond yields exerts direct pressure on the US Treasury market. The moment demand from Japanese life insurers and pensions for US Treasuries weakens or flips to selling, it leads to higher borrowing costs for the US. According to an analysis by EBC Financial Group, when the US-Japan interest rate differential compressed below 200 bps, carry trade stress historically increased sharply, and a pattern of forced liquidations accompanied USD/JPY implied volatility exceeding 15%.^¹⁷ Currently, as the Fed's rate-cutting cycle and the BOJ's hiking cycle interlock, this interest rate differential is gradually narrowing.

06. Historical Analogies and Structural Differences

Comparison with the 2022 UK Mini-Budget Crisis

The January 2026 JGB plunge is structurally similar to the 'Gilt crisis' triggered by UK Prime Minister Liz Truss's tax cut announcement in September 2022. At that time, the UK 30-year government bond yield surged 130 bps in just two days, driving pension funds' Liability-Driven Investment (LDI) strategies to the brink of collapse, prompting the Bank of England to step in with a £75 billion emergency purchase to extinguish the fire. The difference lies in the scale and the BOJ's capacity. While the Bank of England had a relatively light debt structure, Japan's national debt-to-GDP ratio exceeds 260%.^¹⁸ If the BOJ, having abandoned YCC, steps in to execute massive bond purchases again, policy credibility risks being fundamentally undermined.

An Inverted Similarity to the 1990s Japanese Bubble Collapse

While the collapse of the Japanese bubble in the 1990s gave birth to long-term deflation and downward pressure on interest rates, the current structure is its inversion. However, only the direction of the mechanism is opposite; the essence remains the same: the moment the nonlinear interaction between asset prices and policy crosses a critical threshold, it creates an unpredictable feedback loop. ABN AMRO projects the yen to strengthen against the dollar in 2025-2026, yet analyzes that Japan's GDP growth rate will remain below its potential growth rate at 0.8% in 2025 and 0.7% in 2026.^¹⁹

07. Variables and Limitations: The Boundaries of Normalization

The BOJ's Dilemma: The Shock of Hiking vs. The Cost of Freezing

The structural dilemma facing the BOJ is vivid. If it continues to raise interest rates, ultra-long JGB yields will rise further, deepening the fiscal burden and life insurer losses, and delaying economic recovery. Conversely, if it freezes or cuts rates, inflation will persistently exceed the 2% target, continuing the vicious cycle of a weak yen and rising import prices. As CNBC analyzed, the BOJ is facing a "stark choice."^¹²

Tension Between the Takaichi Cabinet and BOJ Independence

In February 2026, the IMF officially recommended that Japan continue hiking rates and refrain from fiscal easing, assessing that the BOJ's independence and credibility are "appropriately maintained." Simultaneously, it directly warned that Prime Minister Takaichi's pledge to cut the consumption tax would "erode fiscal space and increase fiscal risks."^⁴ A 2025 analysis by Goldman Sachs predicted that rather than exerting direct pressure on the BOJ, the Takaichi cabinet would choose to indirectly foster an accommodative environment through massive fiscal spending.^²⁰

Macro Scenario: Probabilistic Future Trajectories

The scenarios below are constructed based on 2025-2026 BOJ path forecast data from Goldman Sachs, ABN AMRO, Nomura, Oxford Economics, and EFG International. Due to a lack of convergence among institutional figures, quantitative probabilities for each scenario are omitted.

Scenario A (Base Case): Biannual Pace of Hikes, Gradual Yen Strength, Controlled Carry Unwind

According to the baseline scenarios of Goldman Sachs and EFG International, the BOJ will hike once on a biannual cycle in 2026 (expected in June) to reach 1.0% by year-end, converging on a terminal rate of 1.25% in 2027.^³ The yen gradually appreciates against the dollar, and further unwinding of the carry trade proceeds sporadically but without the violence of August 2024. Ultra-long JGB yields gradually stabilize through the Ministry of Finance's issuance adjustments and the BOJ's QT pacing. ABN AMRO points to high domestic ownership and the BOJ's role as buffering factors for Japan's debt problem.^¹⁹

Scenario B (Structural Shift Case): Yen Surge and Recurrence of Global Carry Unwind

According to an analysis by State Street, if the USD/JPY exchange rate breaches 160 again, a scenario is triggered where the BOJ executes two hikes within 2026, pushing the terminal rate to 1.5%.^²¹ In this case, the US-Japan interest rate differential sharply narrows, and a forced unwinding of the carry trade on par with August 2024 could recur. This is a scenario where simultaneous sell-offs occur in global high-yield assets (US Big Tech, emerging market equities, cryptocurrencies), pressuring the Fed to step in with liquidity support. The Nikkei enters a correction phase, reflecting corporate profit pressure from the strong yen after a short-term plunge.

Scenario C (Tail Risk Case): Paralysis of JGB Market Function and BOJ Policy Reversal

If the Takaichi cabinet's fiscal expansion persists and long-term JGB yields surge to 5% for 40-year bonds and 3% for 10-year bonds, the BOJ will face pressure to revert to massive bond purchases, equivalent to a de facto resurrection of YCC. In this case, the credibility of monetary policy normalization is fundamentally destroyed, the yen plummets again to 160-170 yen per dollar, and imported inflation re-accelerates. Japanese life insurers' sales of overseas assets expand to a structural scale, causing a supply shock in the US and European government bond markets. This is the scenario where the "flash crash risk" warned by EBC Financial Group materializes.^¹⁷

Conclusion

The normalization of Japan's monetary policy is not simply one country's interest rate decision. It is a declaration of the dismantling of a structure that served as the global financial system's 'cheap funding source' for 30 years. The hundreds of trillions of yen in carry trades formed during the zero-interest rate era, the overseas assets accumulated by Japanese life insurers with those funds, the stable demand for US Treasuries from Japanese investors—August 2024 and January 2026 have already shown how sensitively all of this reacts to a single 0.25 percentage point hike by the BOJ.

What observers must focus on is not the immediate exchange rate or interest rate levels. It is the structure. The fact that Japan's policy shift has structurally elevated the potential volatility of global risk assets, and that the catalyst for the moment this volatility manifests always comes from unexpected places. What is terrifying about the carry trade is not when it accumulates, but when it collapses, and that collapse pierces through all asset classes. The market global investors currently inhabit is a world where Tokyo bond yields determine the movements of the New York stock market. Without understanding that world, no portfolio can be complete.

※ Disclaimer

This report does not recommend the purchase or sale of any specific assets, nor does it support or criticize any specific regime, government, or politician. It is an article of macroeconomic system analysis based on publicly disclosed data and historical indicators. It is impossible to predict all market variables, and the responsibility for all judgments and subsequent consequences rests entirely with the reader. While the author (Neutral Observer) makes every effort to ensure the reliability of the analysis, the flawless accuracy of the provided information is not guaranteed.

Sources and References

¹ CNBC, Bank of Japan raises short-term rates to highest in 30 years (2025.12.19) — https://www.cnbc.com/2025/12/19/bank-of-japan-boj-rate-cpi-inflation-takaichi-ueda.html

² European Business Magazine, Japan's 40-Year Bond Yield Breaks 4% as Fiscal Fears Trigger Historic Sell-Off (2026.02.25) — https://europeanbusinessmagazine.com/business/japans-40-year-bond-yield-breaks-4-as-fiscal-fears-trigger-historic-sell-off/

³ EFG International, Bank of Japan Raises Rates to 30-Year High (2025.12) — https://www.efginternational.com/us/insights/2025/bank_of_japan_raises_rates_to_30-year_high.html

⁴ Trading Economics, Japan Interest Rate (2026.03.19) — https://tradingeconomics.com/japan/interest-rate

⁵ Nomura Holdings, Japan in the World: Shunto Wage Outlook 2026 (2026.01.08) — https://www.nomuraholdings.com/doc/en/investor/presentation/2026_0108_prem.pdf

⁶ Equiti, Japan Inflation Tests Bank of Japan Policy Outlook (2026.03) — https://www.equiti.com/jo-en/news/market-insights/japan-inflation-momentum-tests-the-boj/

⁷ Bank of Japan, Outlook for Economic Activity and Prices (2025.07.31) — https://www.boj.or.jp/en/mopo/outlook/gor2507a.pdf

⁸ CEIC Data, Bank of Japan's Upward Inflation Spiral (2025) — https://info.ceicdata.com/bank-of-japans-upward-inflation-spiral-unpacking-forecast-revisions-with-point-in-time-data

⁹ Financial News, Yen Breaks 156 per Dollar After BOJ-Govt Meeting... 10-Month Low (2025.11.19) — https://www.fnnews.com/news/202511192014049111

¹⁰ AInvest, Japan's Record ¥122 Trillion FY26 Budget: Implications for Sovereign Debt Markets (2025.12.26) — https://www.ainvest.com/news/japan-record-122-trillion-fy26-budget-implications-sovereign-debt-markets-long-term-yield-trends-2512/

¹¹ IMF, Japan 2025 Article IV Consultation (2025.03) — https://www.imf.org/-/media/files/publications/cr/2025/english/1jpnea2025001-print-pdf.pdf

¹² CNBC, Japan's Record JGB Yields Are Presenting the BOJ with a Policy Problem (2025.12.04) — https://www.cnbc.com/2025/12/04/japan-record-high-jgb-yields-boj-policy-rate.html

¹³ Yahoo Finance / Bloomberg, Japan Bond Meltdown Sends Yields to Record High on Fiscal Fears (2026.01.20) — https://finance.yahoo.com/news/japan-40-bond-yield-hits-031341886.html

¹⁴ BIS, Bulletin No.90: The Market Turbulence and Carry Trade Unwind of August 2024 (2024) — https://www.bis.org/publ/bisbull90.pdf

¹⁵ Foreign Policy, How Japan's Yen Carry Trade Crashed Global Markets (2024.08.08) — https://foreignpolicy.com/2024/08/08/japan-crash-yen-carry-trade-global-markets/

¹⁶ Wellington Management, The Yen Carry Trade Unwind (2024.09.09) — https://www.wellington.com/en/insights/the-yen-carry-trade-unwind

¹⁷ EBC Financial Group, Yen Carry Trade Unwind: Could It Trigger the Next Market Crash? (2025.12.19) — https://www.ebc.com/forex/yen-carry-trade-unwind-could-it-trigger-the-next-market-crash

¹⁸ Financial Content / Market Minute, Japan's Bond Market Rebellion: 40-Year Yields Hit Record Highs (2026.01.22) — https://www.financialcontent.com/article/marketminute-2026-1-22-japans-bond-market-rebellion-40-year-yields-hit-record-highs-as-global-markets-shudder

¹⁹ ABN AMRO, Japan: The Land of the Rising Yields (2025~2026) — https://www.abnamro.com/research/en/our-research/japan-the-land-of-the-rising-yields

²⁰ Goldman Sachs, 2026 Japan Economic Outlook: Steady Fundamentals, Policy Risks Ahead (2026.01.06) — https://www.gspublishing.com/content/research/en/reports/2026/01/06/eefdf592-d197-40da-a74b-dd316dbea9ee.html

²¹ CNBC, Bank of Japan Raises Economic Growth Forecasts, Holds Rates at 0.75% (2026.01.23) — https://www.cnbc.com/2026/01/23/boj-rate-decision-snap-election-takaichi-gdp.html