Yen Carry Trade: What Rising Japan Yields Means?

SYNOPSIS

Japan, long the world’s cheapest funding source, is now destabilizing global markets as inflation rises, bond yields surge to multi-decade highs, and the Yen weakens. With soaring debt, rising defence spending, and costly stimulus, Japan’s tightening burden threatens worldwide financial stability.

Japan isn’t just moving the yen it’s shaking the entire global financial system, and India will feel the aftershocks.

There isn't currently a war, an election, or a recession that is the most eye sighted force in international markets. It is Japan. For decades, global markets have relied on credit powerhouse - Japan. Its near zero interest rates and stable Yen created as the most reliable funding source. Trillions of Yen quietly flowed through carry trades by powering growth, liquidity and risk taking across continents. But that long trusted promoter is now shifting and when it moves, the entire financial world feels the turbulence. In November 2025, Japan's inflation hit 3.0% and their long-term government bond yields surged to levels which was not seen since 1999. The 30-year yield moved past 3.39-3.41%, the 40 year yield touched 3.75%, the 20 year yield crossed 2.83-2.85%, and even the 10 year yield rose to around 1.83%, this level was seen in 2008. At the same time, the Yen weakened to around 157.5 per dollar and hit a record low against the Euro. Instead of behaving like a safe heaven, the Yen is now being sold.

At the centre of this is Japan's debt problem; Government debt is around 230% of GDP, roughly $9 trillion, and each 0.5% increase in interest rates adds around $45 billion in annual debt costs. On current yield levels, interest payments will account to more than 10% of total tax revenue, a point at which fiscal breakdown can happen and which has historically occurred. Over this, country is also being forced into massive new spending because China has conducted 25 unauthorised entries near Japanese waters this year, forcing Japan to raise defence spending to almost 2% of GDP which is nearly 9 trillion Yen annually. Adding a new stimulus package of 21-25 trillion Yen, Japan is now committing to bigger deficits as borrowing becomes more expensive.

The Bank of Japan is trapped either raise rates and risk collapsing the debt market or keep rates low and let inflation swipe away savings. It has chosen the second path, helping Japan into a cycle of fiscal dominance and financial repression.

This is where the Yen carry trade has become a global threat. For almost 30 years banks, hedge funds, and institutions borrowed cheap Yen and invested it elsewhere. That trade is estimated between $350 billion and $4 trillion, and probably more when derivatives are included. So as long as the Yen stays weak, the trade works. But if it strengthens near to 152 per dollar, returns will disappear and then the unwinding begins. That unwinding would force selling across stocks, bonds, and all emerging markets specially India. We already saw in July 2024, when the Nikkei fell 12.4% in a day and the Nasdaq dropped 13%. A full unwinding situation could be far worse, with emerging market currencies down 10 to 15% and global equities sliding nearly 12 to 20%. On top of this, Japanese investors hold around $3.6 trillion in foreign assets. As yields rise at home, they would tighten global liquidity and push world interest rates higher.

This won't be easy for India, given tighter global liquidity would mean more volatility on BSE and NSE, pressure on the rupee and rising bond yields increasing borrowing costs for the government and companies. India is better placed than most foreign ownership of domestic debt is below 5% and macro fundamentals are stronger, but no major economy gets insulated in a global crisis. Looking ahead, markets are betting with a 51% chance of a 0.25% rate hike at the December 18–19 Bank of Japan meeting.

If they raise rates, volatility will increase. If they don't, inflation worsens. The message remains the same and that is “the world's cheapest money is disappearing”. Global interest rates are likely to increase 0.5-1.0%, because the world’s largest creditor nation can no longer give subsidized money for global growth. That will affect everything including stock valuations, real estate prices, loan rates, startup funding and majorly household debt. The decades of ultra cheap capital is nearly ending.

As Japan stops easy money, India will feel the shockwaves. The markets would be volatile and borrowing costs would be high. Thus, in the long run the Indian economy growth will slow down.

Parth Ajmera