Historically, interest rates in Japan have been next to nothing. Japanese and global institutions have taken advantage of this. They borrowed the yen cheaply, converted to dollars and bought US treasuries, US stocks, and various US investments. They make their returns in the US and get big profits. They can then easily convert their dollars back to yen to cover their loans with minimal interest as for quite some time Japan has had near zero interest rates and the Japanese yen typically declines in value against the US dollar.
Right now, Japan has a big problem. They’re dealing with inflation for the first time in years like everyone else is. Their current government has a plan to engage in fiscal stimulus, which is only gonna warm up inflation. The Japanese yen is currently in freefall with rising inflation. The US has actually teamed up with Japan to try and push up the yen however, the intervention has largely been unsuccessful.
What I anticipate will happen is that Japan is going to get forced to raise interest rates to deal with inflation and the devaluation of its currency. That means appreciation of the yen and an increase in interest rates. Once this happens, the carry trade will collapse. Higher interest rates means borrowing costs go up. These US investments no longer make sense.
Ultimately, Japanese institutions and other firms will have to sell their assets, buy back the yen and cover their trades. This will be a disaster as a massive surge in demand for the yen will lead to rapid appreciation of the currency. This will force a rapid unwinding of the yen carry trade as everybody wants to cover their debts before the yen’s value increases too much and they lose too much money.
I anticipate this will mean very rapid selling of stock, bonds, treasuries, and other US assets. It will have massive negative, implications for the market. The yen carry trade is estimated to have a total exposure of 4 trillion dollars.
This is not financial advice.