The Japanese Yen makes a strong comeback! Fiscal concerns ease + safe-haven inflows, with the Yen set to post its strongest weekly gain since November 2024.

The Wall Street Journal Finance App has learned that as the market increasingly believes that Japanese Prime Minister Fumio Kishida’s decisive victory will enable the Japanese government to expand stimulus measures while maintaining bond investors’ confidence in fiscal policy, the yen exchange rate (yen against the US dollar) is heading toward its largest weekly gain since November 2024. The yen has appreciated for four consecutive trading days, gaining approximately 2.8% so far this week. Additionally, as the stock market faces large-scale sell-offs due to AI disruption expectations and risk assets like cryptocurrencies are being sold off more aggressively, strong safe-haven demand is also supporting the yen exchange rate. However, with the yen strengthening significantly, some investors are beginning to worry about the risk of large-scale unwinding of yen carry trades, which could trigger sharp volatility across equities, bonds, and forex markets.

Investors interpret Kishida’s decisive victory as reducing political uncertainty and lowering the risk of the worst fiscal outcomes, which helps boost the yen and causes Japanese long-term government bond yields to retreat from the multi-year highs touched last month. Japanese Prime Minister Fumio Kishida acknowledged market concerns over the “two-year consumption tax cut on food” at a press conference on Monday and reiterated plans to avoid financing this measure through issuing large amounts of debt.

Sumitomo Mitsui Trust Bank trader in New York, Yamatomo Gaku, said, “Since the Liberal Democratic Party (LDP) won overwhelmingly, concerns over fiscal policy have eased, and expectations of the Bank of Japan raising interest rates have increased, driving the yen higher.”

Atsushi Mimura, Japan’s top foreign exchange official, stated that despite the yen’s sharp rise this week, the government remains highly alert to foreign exchange volatility. Markets are worried that the US and Japanese governments might jointly intervene to support the yen, which also helps limit its decline.

“Following Prime Minister Fumio Kishida’s historic landslide victory, traders are beginning to price in a relatively rare policy mix in Japan—tax cuts without worsening the deficit—potentially supported by internal funding pools. The risk is that this could involve large-scale selling of foreign exchange reserves—initially benefiting the yen through short-term buying—but also increasing forex market volatility due to the lack of a clear financial script on how far officials are willing to go,” said Michael Ball, macro strategist at Bloomberg Strategists.

Earlier, on January 23, after reports of the Federal Reserve Bank of New York conducting a “rate check,” the yen surged significantly, but after US Treasury Secretary Scott Bessent stated that the US “absolutely has no intention” of intervening in the forex market, the yen weakened markedly. Recently, Japanese Finance Minister Shunichi Katayama said she maintains close contact with Bessent and shares the responsibility of maintaining stability in USD/JPY, which has also fueled expectations of joint US-Japan intervention in the yen.

The recent rise in expectations for the Bank of Japan to raise interest rates is also a key driver of the yen’s appreciation. Several BOJ Monetary Policy Committee members have emphasized the need for “timely rate hikes.” Overnight index swaps show that the probability of the BOJ restarting rate hikes in April has increased to 78%. Investors will closely watch speeches by BOJ MPC member Nao Nakatani on Friday and US CPI data to assess the outlook for the US-Japan interest rate differential and yen exchange rate trends.

Global Stock Markets Face the “Damocles Sword”: Yen Carry Trades

Yen carry trades are essentially a “Damocles sword” hanging over global risk assets such as stocks, cryptocurrencies, and high-yield corporate bonds. This highly leveraged cross-market financing and risk exposure strategy can quickly become invalid when fundamental conditions change—such as narrowing bond yield spreads or yen appreciation—and can amplify shocks through feedback mechanisms, impacting the still-bullish global stock markets, and potentially affecting bonds and forex markets worldwide.

A recent report by Wall Street’s BCA Research describes yen carry trades as “a ticking time bomb in the global financial markets.” Under the backdrop of rising expectations for BOJ rate hikes and Prime Minister Kishida’s stimulus policies potentially pushing long-term government bond yields higher, this long-standing hedge fund strategy favored by traders faces the risk of large-scale unwinding, which could trigger severe reverse shocks.

For years, Japan’s ultra-low interest rate environment has kept the cost of yen financing extremely low, encouraging investors to borrow yen and invest in higher-yielding risk assets (such as US stocks, European and US bonds, emerging market assets) to earn “interest rate differentials.” This low-cost yen financing model was widely adopted during periods of abundant global capital and high risk appetite, accumulating enormous leverage positions. Over time, these positions have become systemic risks, relying on the persistence of yield spreads and a weak yen. However, if risk assets decline or the yen strengthens sharply, or if Japanese government bond yields surge, these carry trades can rapidly unwind.

The rising expectation of BOJ rate hikes combined with fiscal stimulus and supply pressures that push long-term Japanese bond yields higher and increase volatility will weaken the foundation of “borrowing yen to buy high-yield assets,” raising the likelihood of forced deleveraging during risk-off episodes. Several BOJ MPC members have recently emphasized the need for “timely rate hikes,” and market bets on further BOJ rate increases are rapidly intensifying.

However, fiscal stimulus may temporarily sustain carry trades through “rising risk appetite/weaker yen” dynamics, so the real trigger for large-scale unwinding is often a combination of upward rate hike expectations, deteriorating risk sentiment, and yen appreciation—not a single variable.

Senior Wall Street strategist Arthur Budaghyan’s team at BCA believes this carry trade is at risk of collapsing suddenly, similar to the crashes in 2008, 2015, and 2020. During those periods, rapid deterioration in global risk sentiment triggered sudden deleveraging, with investors rushing to buy safe-haven yen.