Japan’s 10-year government bond yield has risen above 3% for the first time since September 1996, putting renewed pressure on one of the market’s most widely used sources of cheap funding: the yen. The move raises the risk that leveraged positions financed in Japan could be cut back quickly if the Bank of Japan tightens policy further or the currency begins to strengthen sharply.
The yield reached its highest level in nearly three decades as traders priced in higher Japanese interest rates, persistent inflation and growing fiscal concerns. Japan’s two-year government bond yield also recently climbed to 1.746%, its highest level in more than 30 years, underscoring that expectations for tighter policy now extend well beyond the long end of the bond market.
Markets have fully priced a 25-basis-point Bank of Japan rate increase in September from the current 1% policy rate, while some participants anticipate another move in October. Bank of Japan Governor Kazuo Ueda has said officials will discuss rates at every policy meeting. Hajime Takata, a policy board member viewed as relatively hawkish, has cautioned that a quarter-point increase is not predetermined.
U.S. Treasury Secretary Scott Bessent has warned that disorderly yen moves could force traders to close leveraged positions across markets. Such a chain reaction, he said, could ultimately raise borrowing costs for U.S. households and companies as volatility spreads from currencies and bonds into credit markets.
Carry trades face a more expensive funding currency
The yen carry trade typically involves borrowing yen at low interest rates and using the proceeds to buy assets with higher expected returns, including foreign government bonds, higher-yielding currencies, equities and, in some cases, digital assets. The strategy depends on stable exchange rates and low Japanese borrowing costs. A rising yen or higher Japanese rates can quickly erode the return on those positions.
The trade has grown as the yen stayed close to 160 per dollar and Japanese rates remained well below those in the United States and other major economies. Bank of America’s latest global fund manager survey listed short-yen positioning among the world’s three most crowded trades, indicating that many market participants remain exposed to a reversal in the currency.
Capital Economics cited data showing that outstanding loans from Japanese residents to overseas borrowers exceeded their 2024 peak in early August. Lending by foreign bank branches in Tokyo to their overseas head offices also reached its highest level since the global financial crisis, according to the research firm. Those figures suggest that yen-based funding remains deeply embedded in global financial flows even after Japan began moving away from ultra-loose monetary policy.
Japan’s earlier rate increases showed how sensitive markets can be to changes in the funding outlook. When the Bank of Japan lifted its policy rate to 0.25% two years ago, global markets experienced sharp moves that were widely linked to a reduction in carry-trade exposure. A repeat would not necessarily follow the same pattern, but the cost of maintaining yen-funded positions has continued to rise.
Crypto markets remain vulnerable to leveraged deleveraging
Digital-asset markets could be particularly exposed if a rapid yen rally triggers broad deleveraging. Cryptocurrency trading operates continuously and relies heavily on derivatives, margin financing and automated liquidations, conditions that can amplify price moves outside regular equity-market hours.
The Bank for International Settlements has reported that open cross-border yen loans exceed $260 billion. A broader measure covering currency swaps places the value of off-balance-sheet dollar debt owed by non-U.S. entities through foreign-exchange swaps and related instruments near $14 trillion. These markets are not a direct measure of crypto exposure, but they illustrate the scale of global funding structures that can be affected when currency volatility rises.
In August 2024, a rapid strengthening of the yen coincided with steep declines across major digital assets, with the largest cryptocurrencies falling roughly 20% to 25% in a single day, according to market data from that period. The episode led to widespread liquidations as leveraged accounts were closed after collateral values fell.
A stronger yen would not automatically produce another crypto sell-off. Bitcoin and other tokens also respond to U.S. interest-rate expectations, equity performance, spot-market demand and flows into regulated products. Yet an abrupt unwinding of positions financed with cheap yen could remove liquidity from risk assets at the same time that derivatives markets are already prone to forced selling.
Japanese asset allocations are the longer-term question
The immediate focus is on currency volatility and Bank of Japan policy, but the larger issue is whether higher Japanese yields eventually persuade domestic institutions to shift money home from overseas markets.
Japan remains the largest foreign holder of U.S. Treasuries, with holdings above $1 trillion, largely held by financial institutions. Japanese life insurers and pension funds have long looked abroad for yields that were unavailable in their domestic bond market. Higher returns on Japanese government bonds could reduce the incentive to hedge foreign holdings or add to overseas fixed-income positions.
Goldman Sachs analyst Kamakshya Trivedi has said yen-funded carry trades have held up better this year than during the 2024 intervention period. He argued that a broad and lasting reduction in those trades would probably require Japanese domestic institutions to repatriate substantial sums from overseas assets.
Morgan Stanley analyst Andrew Lord has similarly pointed to continued strong buying of U.S. assets by Japanese buyers, with no clear evidence of a major retreat into domestic holdings. That makes a sudden, system-wide reversal less certain than the jump in yields alone might imply.
Japan’s 30-year government bond auction on Thursday will offer another test. Nomura strategist Naka Matsuzawa has said strong demand from life insurers could reinforce expectations that institutions are beginning to favor domestic bonds. Other market participants have noted that insurers have been waiting for 20-year Japanese government bond yields to reach roughly 2.5% to 3%, although concerns over further price declines have limited large-scale buying so far.
Fiscal policy adds pressure to bonds and the yen
The rise in yields has also unfolded alongside concern over Japan’s fiscal direction. Prime Minister Sanae Takaichi’s government has signaled support for larger fiscal stimulus, adding to questions over debt issuance and long-term fiscal stability. That backdrop has coincided with a weaker yen and higher government borrowing costs.
Joint Japan-U.S. actions in July and August temporarily lifted the yen, though more than half of that move later reversed. Foreign holders of Japanese equities can also contribute to yen weakness when they hedge their stock exposure by selling the currency, a dynamic that may intensify during rising equity markets.
For crypto traders, the near-term risk lies less in the level of Japanese yields alone than in a rapid change in the yen’s direction. A slow, well-signaled Bank of Japan tightening cycle would give markets more time to adjust. A sudden currency surge, combined with crowded short-yen trades and elevated leverage across risk assets, would leave far less room for orderly repositioning.
Worried about yen carry trades unwinding? Understand the mechanics and risks in our guide on carry trading today.
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