The rapid unwinding of the Japanese yen carry trade is reshaping global markets, prompting asset owners to reassess risk, liquidity, and the interplay between currency moves and portfolio returns. Goldman Sachs Research researchers Kamakshya Trivedi and Praneet Shah—specialists in Global Foreign Exchange, Interest Rates, Emerging Markets Strategy, and Global G10 FX Options Trading—explain what the carry trade is, why its sudden reversal matters, and the potential implications for investment portfolios. This discussion was captured in an episode recorded on August 12, 2024, a moment when market volatility around currency dynamics was front and center for many institutional investors.
Understanding the Yen Carry Trade: Mechanisms and Current Dynamics
The yen carry trade is a strategy that has played a pivotal role in global financial markets for years. It involves borrowing funds in jurisdictions with ultra-low or negative real interest rates, often in Japanese yen, and investing those funds in assets denominated in higher-yielding currencies, such as the US dollar, euro, or other developed market currencies. The appeal rests on the interest rate differential: investors borrow in a low-cost currency and invest in higher-yielding assets, earning a positive carry as long as exchange rates remain favorable and the interest rate gap persists.
In practice, traders engage in a combination of spot FX positions, forward contracts, and options to manage exposure, funding costs, and potential volatility. The carry trade can amplify returns when global monetary conditions are supportive: stable yen, higher yields abroad, and a compatible risk environment that allows for leveraged positioning without excessive credit risk. However, the carry trade is also sensitive to shifts in policy outlook, relative currency demand, and funding conditions. When a major economy tightens policy, or when market risk appetite shifts, the carry can unwind rapidly as funding becomes more expensive, hedging costs rise, and imports of yen strengthen or weaken in ways that erode profitability.
The current dynamic—an accelerated unwind of yen carry positions—reflects a confluence of factors. A combination of rising U.S. yields, a reassessment of global growth trajectories, and persistent or renewed volatility in risk sentiment has made funding costs in yen more burdensome for some traders and funds. At the same time, the Japanese authorities’ policy stance, and how the Bank of Japan (BOJ) communicates its future path, shapes expectations about the yen’s direction and the attractiveness of carry trades in the near term. As a result, liquidity conditions in FX markets can become more fragile, and cross-border capital flows may reprice rapidly in response to new information or shifts in risk tolerance.
From a mechanism standpoint, the unwind of the yen carry trade often involves a de-leveraging process. Traders reduce their net long exposure to higher-yielding assets, or they hedge more aggressively against currency depreciation. This can lead to broader market moves beyond the currency market alone, influencing equities, fixed income, and commodity markets through feedback channels that magnify risk premia or alter correlations between asset classes. The pace and magnitude of unwind depend on the interaction between funding costs, currency volatility, and macroeconomic signals, such as inflation data, employment readings, and central bank communications across major economies.
Why the Carry Trade Matters for Global Markets
Carry trades, and their unwinding, matter because they influence several core dimensions of financial markets. First, they affect funding conditions and liquidity. When yen funding becomes costly or unstable, global asset managers may face tighter constraints on leverage, margin, and liquidity provision. This can reduce the capacity of investment funds to take on new risk, potentially compressing risk premia and altering expected returns across asset classes. Second, currency movements associated with unwind episodes can propagate through the system. A sharper yen appreciation or depreciation can alter the relative pricing of assets worldwide, influencing corporate earnings translation, revenue diversification, and the attractiveness of foreign investments for multinational companies.
Third, volatility dynamics receive a narrative boost from carry-trade flows. As participants reposition, volatilities can spike in FX and correlate with shifts in equities and fixed income. This cross-asset volatility can imprint on implied volatility surfaces in options markets, affecting hedging costs and risk management strategies for banks, funds, and non-financial corporations. Finally, the carry trade has implications for policymakers. The interplay between domestic policy stances (such as the BOJ’s framework for yield curve control or its inflation targeting) and global funding conditions can feed back into currency demand, investor confidence, and the pricing of risk in financial markets.
Goldman Sachs researchers emphasize the need to differentiate between headline moves and underlying structural shifts. A rapid unwind might reflect a regime change in funding costs and risk appetite, rather than a temporary liquidity event. In such cases, the longer-term implications hinge on how policy signals evolve, how other central banks adjust their own policy trajectories, and how market participants adapt their portfolios to changing correlations and risk premia. The episode featuring Trivedi and Shah provides a lens into these dynamics by combining macro insights with practical implications for how institutional investors might recalibrate exposure in a world where yen carry trades are no longer funding paradise, but a source of renewed risk and opportunity.
Impacts on Investment Portfolios and Asset Allocation
When carry trades unwind, portfolio construction and risk management move to center stage. For investors, the path from currency dynamics to portfolio outcomes involves multiple layers of consideration. The first layer concerns currency exposure. If the funding currency (yen) strengthens, it can compress returns on carry positions funded in yen, reducing the payoff from carry strategies that depended on a stable or weakening yen. Conversely, if the yen strengthens in a way that forces hedge costs to rise, investors may reweight exposures to maintain target risk-adjusted returns.
The second layer involves cross-asset correlations. Unwind dynamics can alter the usual relationships between FX, equities, and fixed income. For example, carry unwinds that coincide with rising yields in U.S. Treasuries may push dollar strength higher and equity risk premia lower, reshaping expected performance for a diversified portfolio. The third layer is liquidity and funding risk. As the market experiences a wave of deleveraging, investors with high leverage or thin liquidity profiles might face margin calls, forced selling, or restricted access to financing. This can have a broad, sometimes procyclical impact on asset prices, particularly in crowded trades where many funds run similar exposures.
Practical portfolio implications include strategic and tactical adjustments. Strategically, asset allocators may reconsider the weight placed on FX carry strategies within overall risk budgets. They may seek to diversify carry exposures across currencies with more robust funding dynamics or lower sensitivity to a single policy regime. Tactically, managers might adjust hedging intensity, scale back leverage, or implement dynamic risk controls that respond to real-time signals from currency markets, volatility regimes, and macro surprises. In the context of the yen carry unwinding, a typical response would involve a reassessment of exposure to yen-denominated funding, re-evaluation of hedges against yen exposure, and a careful balance between the potential for carry benefits and the risks posed by rapid moves in currency and rates.
In addition to currency strategies, fixed income allocations could experience shifts. Higher-yielding assets in dollar or euro-denominated markets may respond to changing carry dynamics with adjustments in duration, credit risk, and liquidity premia. Equities, particularly those with dollar-denominated earnings or global supply chains sensitive to currency shifts, can exhibit earnings volatility that translates into price movements. Commodities, which are often priced in dollars, may also respond to the broader risk sentiment and the demand for protective hedges amidst currency volatility. Portfolio managers must evaluate how these cross-asset interactions affect risk budgets, rebalance horizons, and the expected risk-adjusted returns over multiple scenarios.
Another important consideration is regulatory and structural risk. Wealth and asset managers face evolving capital requirements, liquidity coverage ratios, and stress-testing frameworks that incorporate cross-border funding and currency risk. Effective risk governance demands scenario analysis that captures how a yen carry unwind interacts with other potential shocks—such as inflation surprises, geopolitical tensions, or policy surprises in major economies. The takeaway for portfolio construction is a call for proactive, disciplined risk management that uses a multi-asset, multi-scenario lens to navigate a complex and interconnected currency environment.
Policy Context: Bank of Japan, Policy Tools, and Market Reactions
Policy context is a central driver of carry-trade dynamics. The Bank of Japan’s policy stance, including its yield curve control framework and inflation targets, shapes the attractiveness of yen funding and the broader currency environment. Any shifts in the BOJ’s policy path—whether in the form of policy normalization, changes in long-term yields, or adjustments to asset purchases—can quickly alter carry-trade profitability and investor sentiment. The pace and clarity of BOJ communication matter as well, because forward guidance helps market participants price the likely trajectory of currency and rates.
Global policy peers also influence carry dynamics. For instance, changes in U.S. monetary policy expectations—such as anticipated pace of rate hikes or cuts, balance-sheet normalization, and inflation expectations—alter relative attractiveness of carry trades financed in yen and invested elsewhere. European policy developments, including guidance from the European Central Bank, can likewise shift capital flows and risk appetite. Investors must consider how cross-border policy signals interact with domestic dynamics in Japan to create contagion or diversification channels for carry strategies.
Policy uncertainty can inject abrupt shifts in funding costs and hedging strategies. When traders face ambiguous outlooks or conflicting signals across major central banks, risk premia on carry trades may widen, and hedging costs can rise. This, in turn, affects portfolio performance and liquidity, especially for funds with concentrated carry exposures. Conversely, if policy paths converge toward a more predictable regime—such as slower inflation, stable growth, and anticipated gradual normalization of yields—carry trade profitability may regain some resilience, albeit still contingent on currency moves and macro surprises.
From a strategic viewpoint, investors should monitor policy anchors and communicate with risk managers about assumptions embedded in carry strategies. Even if carry positions are temporarily unattractive due to funding costs, a well-structured framework could preserve optionality to re-enter or scale carry exposures as conditions stabilize. The insight offered by Trivedi and Shah emphasizes that understanding policy nuance, funding costs, and currency dynamics is essential for interpreting the risk-reward balance of yen carry trades in a shifting global environment.
Transmission Channels Across Asset Classes
The unwinding of yen carry trades does not stay contained within the currency sphere; it reverberates across asset classes through several transmission channels. The first channel is funding and liquidity propagation. When yen-based funding becomes more expensive, financial institutions reduce leverage and non-hedged exposure, which reduces liquidity in funding markets. This can lead to more pronounced price moves in assets priced in the affected currencies and in instruments that rely on short-term funding, such as certain FX forwards and swaps.
The second channel concerns currency exposure and corporate earnings. Multinational corporations with revenue streams and costs spread across currencies face translation and transaction exposure. If yen movements are volatile, these firms may experience changes in reported earnings, especially when revenue is converted into yen or when debt service is denominated in foreign currencies. This, in turn, can influence equity valuation and risk appetite among global investors who hold these equities.
A third channel is risk sentiment and volatility. When carry unwinds intensify, volatility in FX markets tends to rise, which spills over into equity and fixed income markets. Higher realized and implied volatility increases hedging costs and can lead to risk-off behavior, reducing speculative activity and pressuring a broad range of assets. In addition, the correlation structure among asset classes may shift. For example, equities and bonds often behave differently during carry unwind episodes, but a sharp currency movement can cause temporary correlations that diverge from longer-term norms.
The fourth channel is macroeconomic signaling. Currency moves reflect, in part, expectations about growth, inflation, and policy. A significant yen appreciation or depreciation can inform investor expectations about Japan’s economic trajectory and its policy response. This feeds into global macro trades that traders use to express views on growth differentials and central bank paths. Consequently, systematic investors may adjust factor exposures, duration, or macro-themed strategies in response to evolving currency dynamics.
In practice, the magnitude of these transmission channels depends on the scale of the unwind, the speed of funding-cost changes, and the resilience of market infrastructure. A rapid unwinding in a crowded carry trade can create a self-reinforcing loop of volatility that magnifies price moves not only in FX but also in related asset classes. Investors should be prepared for heightened short-term turbulence, even as longer-term structural factors—like productivity trends, demographics, and technological advancements—continue to shape fundamental value across markets.
Risk Management, Hedging, and Tactical Considerations
Effective risk management in a changing yen carry environment requires a structured, disciplined approach that integrates currency, rate, and credit risk. The following considerations are commonly reflected in institutional risk frameworks when addressing carry unwind risk.
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Currency hedging: Portfolio managers may reassess hedging strategies for yen exposure, including dynamic hedging that responds to shifting volatility regimes, funding costs, and policy signals. Hedging may involve a mix of options, forwards, and cross-currency hedges to optimize cost and protection.
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Leverage management: In carry strategies, leverage magnifies both gains and losses. Risk controls should emphasize prudent leverage levels, stress testing under sudden currency moves, and contingency plans for liquidity stress scenarios.
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Diversification: Reducing concentration risk across a single carry trade or specific currency regime can help mitigate downside risk. Diversification across currencies, asset classes, and geographic exposures may improve resilience to regime changes.
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Scenario analysis and stress testing: Firms should conduct robust scenario analyses that incorporate possible sequences of policy surprises, abrupt currency moves, and shifts in global risk appetite. This includes analyzing tail-risk events and their implications for liquidity, collateral, and financing conditions.
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Liquidity risk management: The unwind can create liquidity strain for market participants, particularly during times of market stress. Institutions should ensure sufficient liquidity buffers, access to diversified funding lines, and robust collateral frameworks to navigate potential liquidity squeezes.
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Counterparty risk: In volatile environments, counterparty defaults or distress can rise. Risk management programs should include counterparty credit risk assessments, exposure monitoring, and credit hedges where appropriate.
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Operational readiness: In fast-changing markets, operational risk—such as trade capture accuracy, settlement efficiency, and risk reporting—needs to be minimized. This includes ensuring systems can handle rapid re-pricing and large intraday movements.
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Communication and governance: Clear internal governance around carry strategies, including explicit risk appetites and decision rights, helps align execution with overall investment objectives. Transparent internal communication is essential during periods of elevated volatility.
For practitioners, the practical takeaway is to maintain a balance between exploiting legitimate carry opportunities and preserving a protective risk framework that can adapt to sudden policy and market shifts. The goal is to preserve long-term value while avoiding the pitfalls of crowded trades or fragile funding arrangements that can magnify losses during rapid unwind episodes.
Historical Context and Lessons for Investors
An appreciation of historical carry-trade episodes provides context for interpreting current dynamics. Previous cycles show that yen carry trades have experienced phases of strong profitability followed by abrupt reversals, often connected to shifts in BOJ policy, global yield environments, or episodes of risk aversion. While past performance does not guarantee future results, these episodes offer instructive patterns: changes in policy stance tend to be the primary catalysts for rapid valuation adjustments; funding conditions can tighten quickly in times of global risk-off sentiment; and liquidity can deteriorate in crowded, leveraged markets.
Key lessons for investors include recognizing the importance of flexible strategies that can adapt to regime shifts. Investors should avoid overreliance on a single source of return (such as carry yields) and instead build a multi-faceted approach that can absorb shocks from currency moves, rate moves, and market volatility. Diversification across geographies, asset classes, and investment styles can contribute to resilience. Additionally, a clear framework for risk budgeting and stress testing can help teams quantify the potential impact of carry unwind scenarios on portfolio performance and liquidity.
Historical perspective also underscores the resilience of well-managed institutions that maintain robust risk controls, liquidity management, and disciplined governance. Those organizations typically perform better in regimes characterized by rapid unwinds because they can deploy risk controls, manage funding cost dynamics, and adjust exposures in an orderly manner. While models can help, real-world decision-making under uncertainty remains critical. The synthesis of macro perspective, policy understanding, and practical risk management is essential to navigate a complex carry-trade environment.
Practical Recommendations for Portfolio Construction
For investors eyeing the current landscape, several practical guidance points emerge, informed by the discussion with Trivedi and Shah and grounded in prudent risk management principles:
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Recalibrate carry exposure: Reassess the attractiveness of yen carry strategies within the broader portfolio context. Consider reducing concentration in crowded carry trades while maintaining exposure to well-structured carry opportunities that include built-in risk controls and hedges.
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Strengthen currency risk management: Implement a forward-looking currency risk framework that incorporates regime detection, volatility regimes, and hedging cost expectations. Use a mix of hedging instruments to balance protection with cost efficiency.
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Focus on quality and liquidity: Prefer high-quality assets with robust liquidity profiles, particularly in markets that are sensitive to funding conditions. Ensure that positions can be liquidated or scaled in stressed markets without severe price impact.
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Diversify across regimes: Build a diversified set of carry strategies that span multiple currencies and yield environments, reducing dependence on the performance of a single regime. This approach helps mitigate the risk of regime-specific tail events.
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Embed scenario planning: Regularly run macro and market scenarios that capture the potential paths of policy shifts, currency moves, and risk appetite. Use these scenarios to inform tactical adjustments to portfolios and risk budgets.
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Prioritize risk governance: Align carry-related decisions with a clear risk framework, including escalation paths, limits, and governance checks. Ensure that risk oversight teams are engaged in real-time during instances of rapid unwind.
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Leverage technology and data: Use advanced analytics, real-time data, and stress-testing tools to monitor carry dynamics, currency exposures, and hedging costs. A data-driven approach can enable faster and more precise decision-making.
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Prepare for volatility regimes: Maintain readiness for higher volatility environments, which often accompany carry unwinds. Develop strategies that perform across volatility regimes, including hedged equity allocations and volatility-targeted approaches.
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Review long-term strategic objectives: Align tactical adjustments with long-term goals. Ensure that any changes to carry exposure support the overall investment thesis, risk tolerance, and liquidity needs.
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Engage with currency and macro research: Maintain ongoing dialogue with research teams that track FX dynamics, policy developments, and macro risks. An informed, collaborative approach helps anchor investment decisions in a coherent narrative.
These recommendations aim to equip investors with a balanced, disciplined approach to navigating the carry trade landscape as conditions evolve. The emphasis is on integrating currency insights with broader portfolio theory, risk controls, and dynamic allocation strategies to sustain resilience and potential upside in the face of shifting market regimes.
Scenarios and Stress Testing in a Shifting Regime
To prepare for a range of outcomes, consider constructing scenarios that stress test carry unwind dynamics:
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Mild unwind with gradual policy normalization: A scenario in which policy normalization occurs slowly, currency volatility remains contained, and carry profitability recovers gradually. This setting allows investors to rebuild carry exposure while maintaining disciplined risk oversight.
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Rapid policy surprise and volatility spike: A scenario where a surprise from a major central bank triggers sudden currency moves and funding-cost spikes. In this case, liquidity risk rises, hedging costs escalate, and risk assets experience sharp re-pricing. A pre-planned response, including pre-agreed hedges and liquidity reserves, is crucial.
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Cross-asset contagion event: A shock that affects multiple asset classes simultaneously, such as a geopolitical incident or a large-scale macro shock, prompting correlated selloffs in equities, bonds, and FX. This scenario tests diversification effectiveness and liquidity resilience.
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Currency-centric risk-off regime: A environment where a strengthening yen intersects with risk-off sentiment, causing a broad retreat from carry trades. Portfolio defenses would emphasize quality, liquidity, and liquidity-adjusted risk measures.
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Low liquidity, high volatility background: A regime where market depth is shallow and volatility is high, increasing the cost of hedging and the likelihood of abrupt price moves. This scenario tests execution risk, operational readiness, and governance.
By constructing and monitoring these scenarios, investors can identify vulnerabilities, calibrate exposure, and implement hedging strategies that reduce potential losses while preserving optionality for favorable future moves.
The Road Ahead: Implications for Investors and Markets
The yen carry trade unwind represents a complex, multi-faceted shift with implications for investors and markets worldwide. It underscores the need for careful monitoring of currency dynamics, policy paths, and cross-asset interactions. For professional investors, the focus should be on building robust risk frameworks, maintaining liquidity readiness, and being prepared to adapt exposure in response to evolving conditions. It also highlights the value of collaboration between FX strategists, macro researchers, and portfolio managers to develop integrated approaches that reflect the interconnected nature of modern financial markets.
Looking forward, possible themes that could shape the carry-trade landscape include ongoing policy normalization in major economies, the inflation trajectory and its impact on real yields, and the evolving balance between risk appetite and risk-off behavior in global markets. Traders and investors may seek to balance the potential for carry-based returns against the costs and risks associated with currency movements, hedging, and funding constraints. In this context, the insights from Goldman Sachs Research’s Kamakshya Trivedi and Praneet Shah provide a practical framework for understanding the mechanics, significance, and investment implications of the yen carry unwind, helping market participants navigate a period of heightened complexity with clarity and strategic rigor.
Conclusion
The rapid unwinding of the Japanese yen carry trade poses meaningful challenges and opportunities for global investors. It alters funding conditions, currency dynamics, and cross-asset interactions in ways that require disciplined risk management, strategic diversification, and proactive scenario planning. By dissecting the carry trade’s mechanics, its market-wide impact, and the portfolio implications, investors can better position themselves to navigate regime shifts without sacrificing long-term objectives. The perspectives shared by Kamakshya Trivedi and Praneet Shah illuminate practical pathways for understanding and responding to carry-trade dynamics, emphasizing that informed analysis, prudent risk governance, and flexible portfolio construction remain essential in a world where currency moves can redefine risk and return across markets. Investors and researchers alike should continue to monitor policy signals, funding conditions, and volatility regimes to anticipate shifts and protect capital in an increasingly interconnected financial system.
