Higher Japanese interest rates and rising domestic bond yields are changing the trade’s appeal, but a sustained yen recovery could be the decisive test
Abu Dhabi, UAE – October 2026: The yen carry trade continues to offer returns despite a narrowing interest rate gap between Japan and the United States, according to Nagham, MENA Market Analyst at etoro. While higher Japanese rates have reduced its appeal, recent currency and market movements do not point to a broad unwinding of the trade.
The strategy involves borrowing yen at low interest rates, converting it into dollars and investing in US bonds to capture the difference in yields. In 2024, that interest rate gap exceeded five percentage points, supporting annual returns of around 5% to 6%. Since then, changes in US monetary policy and Japan’s interest rate increases have roughly halved the gap.
“The trade is thinner, but still here,” said Nagham, MENA Market Analyst at etoro. “A smaller return is still a return.”
The size of the trade remains difficult to measure. According to Bank for International Settlements data cited in the analysis, cross-border yen lending reached a record US$2.3 trillion in March. However, much of this represents ordinary lending, while carry positions held through currency contracts are not fully captured in banking data.
Japan’s changing investment landscape is also influencing capital flows. Japanese government bond yields now exceed 3%, strengthening the appeal of domestic assets for banks and insurers that previously looked overseas for higher returns.
In August, Japanese banks, insurers and pension trusts purchased approximately US$25 billion of domestic government bonds, compared with around US$16 billion a year earlier, according to Japan Securities Dealers Association data cited in the analysis.
Japanese investors also sold approximately US$103 billion of US Treasuries between February and July. Nagham’s analysis distinguishes these flows from a carry trade unwind, pointing to domestic institutions bringing funds home and government activity associated with currency intervention.
The analysis also identifies US monetary policy, oil prices above US$100, inflation above 3% and record US borrowing as broader drivers of rising US bond yields.
“An unwind has a shape: borrowers sell assets to raise cash, buy yen to repay their loans, the yen jumps fast, and markets fall with it,” Nagham said.
August 2024 demonstrated that pattern, when a surprise Japanese rate increase was followed by a sharp yen appreciation and a 12% fall in the Nikkei in a single session. September 2026 showed a different pattern: the yen’s initial gains reversed within three weeks, while stocks remained near their highs.
However, the smaller interest rate gap leaves investors with less protection against currency movements. A yen appreciation of less than 3% could erase a full year’s return from the gap.
Japanese pension funds remain a key factor to watch. They have continued buying foreign bonds this year, but a shift towards bringing overseas investments home could create substantial and sustained demand for yen.
“The trade’s cushion is thin,” Nagham said. “What could end it is a yen that jumps and stays up.”
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