Why USD/JPY is losing its carry trade cushion

USD/JPY is losing its carry trade cushion because the assumptions that kept the yen weak for more than a decade are starting to unravel. Japan’s era of near-zero interest rates is edging closer to its end, while the yield advantage that once made borrowing yen irresistible is narrowing. Business confidence among large Japanese manufacturers has climbed to its strongest level since 2021, and the Bank of Japan is widely expected to raise its policy rate to 0.75% at its December meeting.

At the same time, the US dollar is no longer enjoying an unchallenged rate premium. Federal Reserve expectations have stabilised, but no longer move relentlessly higher. As the interest-rate gap compresses and hedging costs rise, the mechanics that supported persistent yen selling are weakening. That shift matters because USD/JPY has been one of the market’s most reliable carry trades - and those trades rarely unwind quietly.

What’s driving USD/JPY?

The core driver behind the change in USD/JPY is the Bank of Japan’s growing confidence that inflation and wages are no longer temporary phenomena. Japan’s inflation has exceeded the 2% target for more than three years, and the latest Tankan survey shows that companies now expect prices to rise by 2.4% one, three, and five years ahead, suggesting that inflation expectations are becoming anchored. 

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That marks a clear break from the deflationary mindset that dominated Japanese policy for decades. Corporate behaviour is reinforcing that signal. Large firms plan to increase capital expenditure by 12.6% in the current fiscal year, while labour shortages are at their most severe since 1991, during Japan’s asset bubble era. 

This tightening labour market supports wage growth, which the BoJ has repeatedly identified as a prerequisite for sustained rate increases. With firms able to pass higher costs on to consumers, policymakers now have a stronger justification to normalise policy without fearing an abrupt demand shock.

Why it matters

For currency markets, this is not just another rate hike story. It is a credibility shift. The yen has long been treated as a funding currency, sold almost by default whenever global risk appetite improved. That reflex was built on confidence that Japanese rates would remain anchored near zero indefinitely. The Tankan data, combined with increasingly hawkish language from Governor Kazuo Ueda, challenges that assumption.

Analysts argue that labour market dynamics are now doing much of the BoJ’s work for it. Capital Economics notes that acute labour shortages “lock in the virtuous cycle between higher wages and higher prices,” giving the central bank room to keep tightening without undermining growth. If investors accept that Japan’s neutral rate lies closer to 1.5–2.0%, USD/JPY valuations above 150 become harder to defend.

Impact on markets and the carry trade

The biggest casualty of this shift is the global yen carry trade. For years, investors borrowed cheaply in yen to buy higher-yielding US and global assets, often leaving currency exposure unhedged because the yen weakened steadily. That strategy worked because funding costs were negligible and the policy outlook was static.

Now, both pillars are wobbling. As Japanese Government Bond yields rise and forward markets price further BoJ hikes into 2026, hedging the yen becomes more expensive. This does not trigger a sudden rush for the exits, but it encourages a gradual unwind. As positions are reduced and hedges are added, structural demand for the yen increases, placing steady downward pressure on USD/JPY, even if US yields remain elevated.

Expert outlook

Markets are increasingly focused on what comes after the December BoJ meeting. A quarter-point hike is largely priced in; the real signal will come from forward guidance. If the BoJ frames policy as moving towards a neutral rate rather than executing a one-off adjustment, the yen’s repricing could accelerate. 

Governor Ueda’s post-meeting press conference will be scrutinised for any indication that policy normalisation extends well into 2026. On the US side, the picture is more balanced. The Federal Reserve’s latest dot plot shows just one rate cut pencilled in for 2026, a firmer stance than markets expected earlier this year. Even so, political pressure and slowing growth indicators limit how hawkish the Fed can become. With US labour and inflation data due this week, USD/JPY volatility may rise, but the broader trend increasingly favours a slow erosion of the pair’s carry-driven support.

Key takeaway

USD/JPY is no longer insulated by the carry trade dynamics that defined it for years. Japan’s improving inflation backdrop, tightening labour market and a more confident Bank of Japan are eroding the structural case for a weak yen. While the adjustment may be slow, the direction is increasingly clear. Traders should watch BoJ guidance, wage data and US macro releases for confirmation that this shift is becoming permanent.

USD/JPY technical insights

At the start of writing, USD/JPY is trading around 155.14, pulling back from recent highs after failing to sustain momentum above the 157.40 resistance level. This area remains a key upside barrier, where traders typically expect profit-taking unless the price can break higher convincingly. On the downside, immediate support sits at 155.10, followed by 153.55 and 151.76; a break below these levels is likely to trigger sell liquidations and a deeper corrective move.

Price action indicates that the pair is slipping back toward the middle of its Bollinger Band range, signalling a cooling of bullish momentum after the earlier rally. This suggests USD/JPY may enter a consolidation phase unless buyers quickly step back in.

The RSI, now around 56, is dipping sharply toward the midline, highlighting weakening momentum and growing caution among buyers. While this does not yet signal a trend reversal, it does point to near-term downside risks if support at 155.10 fails to hold.

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