Yen carry trade in reverse: Japan’s yield shift and its impact on USD/JPY

Japan’s bond market is rewriting the rules of the global foreign exchange market. The country’s 10-year government bond (JGB) yield has surged to 1.73% - its highest level since June 2008 - as markets brace for a ¥17 trillion (£88 billion / $110 billion) fiscal stimulus and a further reduction in Bank of Japan (BoJ) bond purchases. The move signals the beginning of a new phase: the yen carry trade in reverse.

As domestic yields rise, Japanese investors are increasingly repatriating funds from abroad, strengthening the yen and unsettling one of the world’s longest-standing funding trades. 

The question now dominating markets is clear - will this shift pull USD/JPY back from its multi-decade highs near 156, or force the BoJ and Ministry of Finance (MoF) to intervene once again to stabilise the currency?

Key takeaways

• Japan’s 10-year bond yield has reached 1.73%, the highest since 2008, as markets price in rising inflation, fiscal stimulus, and reduced BoJ support.
  
• The BoJ’s gradual normalisation - with short-term rates now at 0.5% - is driving a global reassessment of the yen’s funding role.
  
• A planned ¥17 trillion stimulus aims to offset Japan’s 0.4% GDP contraction in Q3 but risks adding inflationary pressure.
  
• Rising yields are drawing capital back into Japan, prompting a partial unwinding of the yen carry trade.
  
• USD/JPY faces key resistance near 155–156, a zone where past interventions have been triggered.
  

Japan bond yields go up to breach the 1.7 mark

After nearly two decades of near-zero yields, Japan’s bond market is finally moving under its own weight. 

The 10-year JGB yield, which stayed below 1% for years due to the BoJ’s Yield Curve Control (YCC), has now broken decisively higher - a sign that investors expect sustained inflation, more fiscal spending, and a lighter BoJ hand in the market.

Several forces have converged:

• The BoJ is tapering bond purchases, reducing artificial demand for JGBs.
  
• Short-term policy rates have been raised to 0.5%, marking the end of an era of negative rates.
  
• A massive stimulus plan under Prime Minister Sanae Takaichi is expected to inject over ¥17 trillion into the economy through tax cuts, infrastructure spending, and household support.
  

Together, these dynamics have pushed bond yields to levels unseen since the global financial crisis, marking what analysts describe as the end of Japan’s “zero-cost money” era.

Higher yields despite Japan’s fragile economy

Despite higher yields, Japan’s economy remains fragile. Data from the Cabinet Office show that GDP contracted by 0.4% in Q3, its first decline in six quarters. Weak residential investment and subdued consumer demand dragged growth lower, even as exports rebounded slightly in September.

BNP Paribas economist Ryutaro Kono noted that while the contraction is not “particularly serious”, it highlights uneven recovery momentum. Still, the forthcoming stimulus package - expected to be approved soon - aims to restore confidence and support households facing rising living costs.

Yet the market reaction suggests scepticism. Investors view fiscal expansion as inflationary and debt-heavy. With Japan’s public debt exceeding 230% of GDP, every new round of spending increases pressure on the bond market - and by extension, the yen.

The mechanics: Why higher yields strengthen the yen

The surge in Japanese yields has immediate foreign exchange implications, particularly for the USD/JPY exchange rate.

1. Repatriation of capital

Japan’s institutional investors - who collectively hold trillions of dollars in foreign bonds - are now finding better returns at home. As domestic yields climb, they begin selling U.S. Treasuries, European debt, and emerging market assets to reinvest in JGBs. This process increases demand for yen, supporting its value against major currencies.

2. Unwinding the carry trade

The yen carry trade - borrowing in low-yielding yen to buy higher-yielding assets abroad - has been a cornerstone of global markets for years. With Japanese rates rising, this trade becomes less profitable. Traders must buy yen to repay loans, triggering powerful short-term rallies. 

3. Yield Differentials and Global Comparison

Even with U.S. 10-year yields near 4–5%, Japan’s rapid shift from near-zero to 1.7% is significant. For Japanese investors who once earned nothing on domestic bonds, the new yield environment is competitive enough to slow outflows and boost inflows, tilting currency dynamics in favour of the yen.

Yen policy trade-offs: Growth, debt, and stability

For the BoJ, this shift poses a major challenge. Governor Kazuo Ueda must balance a weak economy, rising inflation, and market volatility. The ¥17 trillion fiscal push could revive domestic demand, but it also risks fueling inflation expectations and adding strain to already high debt levels.

If yields rise too high, the BoJ may need to intervene in bond markets again or issue verbal guidance to temper speculation. Finance Minister Satsuki Katayama has already warned she is “watching FX moves with a sense of urgency”. Historically, such language has preceded yen-supportive interventions, particularly when USD/JPY nears 155–156 - a zone Credit Agricole analysts flag as Tokyo’s soft intervention threshold.

Geopolitics: China tensions and trade headwinds

External risks compound Japan’s policy dilemma. Relations with China have deteriorated following Takaichi’s remarks on Taiwan, prompting mutual travel warnings and raising fears of trade retaliation.

Economists such as Marcel Thieliant at Capital Economics warn that restrictions on rare earth exports or Japanese goods could escalate into a broader trade dispute - one that hurts exporters already under pressure from Chinese electric vehicle competition.

These tensions could trigger safe-haven inflows into the yen, but they also risk weakening Japan’s export engine - another reason why policymakers may resist further currency volatility.

USD/JPY forecast: Scenarios for late 2025

In the near term, a test of 145–148 remains plausible as capital returns home. But if the U.S. Federal Reserve delays rate cuts - keeping U.S. yields high - USD/JPY could stay anchored closer to 150–153.

Either way, the BoJ’s tolerance threshold around 156 is becoming a critical line for traders to watch. Traders can monitor these levels directly on Deriv MT5, which offers live market depth and advanced charting to track yen volatility in real time.

USD/JPY technical analysis

At the time of writing, USD/JPY is trading around 154.72, holding just below a fresh price discovery zone. The RSI sits flat just below the overbought threshold, signalling that bullish momentum remains strong but may be nearing exhaustion if no further upside breakout occurs.

Meanwhile, Bollinger Bands are expanding, indicating an increase in volatility. The price is hugging the upper band, reflecting sustained buying pressure - though such positioning often precedes short-term pullbacks or consolidation phases.

On the downside, immediate support lies at 153.00, with further key levels at 150.00 and 146.45. A break below these levels could trigger sell liquidations or panic selling, especially if sentiment turns against the dollar.

Overall, momentum currently favours the bulls, but with the RSI nearing overbought territory and price extended along the upper Bollinger Band, traders should watch for possible short-term corrections before any continuation higher.

Global ripple effects of yen

Japan’s yield shift is not an isolated story. As the world’s largest creditor nation, any repatriation of Japanese funds can affect global bond markets:

• U.S. Treasuries: Selling pressure from Japanese investors could lift U.S. yields.
  
• Europe and Australia: Investors may rebalance towards JGBs, driving global yield convergence.
  
• Emerging markets: Funding costs could rise as yen liquidity tightens.
  

The implications are profound - the end of Japan’s zero-yield era may gradually unwind two decades of global risk-taking built on cheap yen funding.

Investment and trading implications of yen

For traders, Japan’s bond market is now the most important variable in the yen equation.

• Short-term outlook: Higher JGB yields and repatriation flows could push USD/JPY lower towards 145–148, especially if U.S. yields stabilise.
  
• Medium-term: Fiscal stimulus and persistent inflation may keep yields elevated but volatile, anchoring USD/JPY near 150–153.
  

Intervention watch: If the pair nears 156, expect stronger verbal warnings and possible BoJ/MoF coordination.