What a Yen Carry Trade Unwind Means for Nasdaq and Nikkei Stocks

A yen carry trade unwind forces investors who borrowed cheaply in Japan to pull capital out of global stocks, and the damage to equities can far exceed the move in the currency. In one major unwind, dollar yen fell 13.81% from peak to trough while the Nikkei dropped 27.79% in roughly three weeks and the Nasdaq lost 17.31%. The trigger for the Nasdaq slide was growing evidence that the Federal Reserve could cut rates, news that would normally support tech stocks. The gap between the currency move and the equity losses shows how much borrowed money from Japan sits inside global stock markets.

James Stanley, StoneX Media Senior Market Analyst at StoneX, covers global macro themes across equity indices, currencies and bond markets, with a focus on price action and macroeconomic events. That coverage gives insight into how borrowing in Japan, U.S. interest rate expectations and the dollar yen exchange rate feed into Nasdaq and Nikkei price swings.

Key Themes

• Dollar yen fell 13.81% in one carry unwind while the Nikkei dropped 27.79% in about three weeks.
• Hedge funds borrow from Japanese banks, invest the capital elsewhere and sell yen to offset the currency risk.
• A Bank of Japan signal that rates would not rise halted the unwind and brought buyers back to stocks.

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Yen Carry Trade Borrowing Builds Leverage in Global Stocks

The yen carry trade lets hedge funds and institutions borrow at low rates from Japanese banks and invest the proceeds in assets abroad, including U.S. stocks. The Bank of Japan kept rates low even as inflation rose, which made Japan an attractive place to fund those positions. Stanley traces the resulting boom to policy in Tokyo, calling it "purely financialization, financialization brought upon by a central bank that refused to raise rates even with inflation running higher." As a result, a large share of the leverage behind global equity rallies depends on borrowing costs in Japan staying low. When that funding advantage shrinks, the same positions that lifted stocks have to be sold.

Carry traders sell the yen because a sharp move in the Japanese currency can wipe out the return they earn on borrowed money. According to Stanley, a U.S. institution borrowing in Japan does not "want to take on that yen risk" and offsets it by selling the yen in the currency market. Specifically, that hedging flow helps explain a rally of more than 50% in dollar yen over several years, and the weaker yen in turn fed the rise of the Nikkei. The Nikkei gained 141.59% in roughly 15 months from its tariff-driven lows, a surge that Japan's declining and aging population does not explain on its own. For traders, the size of the Nikkei rally is a gauge of how much leverage the yen carry trade has built.

Yen Carry Trade Unwind Hits the Nikkei and Nasdaq Together

A yen carry trade unwind begins when the gap between U.S. and Japanese interest rates starts to narrow. "All of a sudden you had motivation for that carry to unwind," Stanley says of the moment softer than expected U.S. consumer price data convinced markets that the Federal Reserve would be able to cut rates. Investors who had borrowed in Japan at low rates suddenly faced lower returns elsewhere and a squeeze on their positions. Consequently, trades built over years came out in a matter of weeks, with dollar yen falling 13.81% from peak to trough. The currency move looked modest on a chart, but it masked how much selling was hitting equities.

The Nikkei fell 27.79% in roughly three weeks during the same yen carry trade unwind, about twice the drop in dollar yen. The Nasdaq lost 17.31% even though the prospect of Federal Reserve cuts should have made it easier for unprofitable tech companies to keep raising money in debt markets. Notably, the Nasdaq slide came on news that would normally lift tech stocks, a sign that the selling was about leverage rather than earnings. The size of the equity losses relative to the currency move shows how far borrowed yen had spread beyond Japan. The reaction, in Stanley's words, "was violent because we saw that leverage coming out really fast."

Bank of Japan Restraint Halts the Yen Carry Trade Unwind

Stanley notes that the yen carry trade unwind ended when the Bank of Japan signaled "we're not going to hike. We don't have to hike." Dollar yen found support once the Bank of Japan stepped back, removing the pressure on borrowers to repay yen loans ahead of the next Federal Reserve rate cut. With the threat of a mass-scale unwind gone, investors could keep adding leverage, and buyers returned to stocks with renewed force. The Bank of Japan's rate stance therefore remains the pivot for how much borrowed yen stays invested in global equities.

Yen Carry Trade Stress Surfaces First in Dollar Yen

Yen carry trade stress tends to surface in a handful of linked markets, starting with the dollar yen exchange rate, where a sharp drop marked the last major unwind. U.S. consumer price data and Federal Reserve rate expectations track how fast the interest rate gap with Japan is narrowing. Bank of Japan guidance on rate hikes shows the direction of funding costs for yen borrowers. The Nikkei, which carries much of the leverage built on cheap yen, shows how quickly borrowed money is leaving equities.

 

--- Written by Frédéric Guétin, StoneX Media Producer

--- Expert: James Stanley, StoneX Media Senior Market Analyst