For decades, Japan served as the world’s lowest-cost source of capital. Through aggressive monetary easing, the Bank of Japan (BOJ) purchased large quantities of government bonds and maintained ultra-low and at times negative interest rates. Domestic savers faced negligible returns on cash, while global investors took advantage of near-zero yen borrowing costs to fund investments abroad.

This phenomenon, known as the yen carry trade, became a cornerstone of global financial markets. Investors borrowed cheaply in yen, converted the proceeds into foreign currencies — primarily US dollars — and invested in higher-yielding assets such as US Treasuries. The strategy anchored global yields, supported asset prices, and suppressed volatility across markets.

Japan’s economic posture has begun to change. In December 2025, the BOJ raised its policy rate to 0.75 per cent, signalling a departure from its long-standing ultra-accommodative stance. At the same time, the central bank — previously the dominant buyer of Japanese government bond has reduced its market intervention, allowing bonds to trade more freely.

As a result, Japan’s 30-year government bond yield has climbed to approximately 3.9 per cent, the highest level since issuance. The BOJ’s retreat from yield curve control and negative interest rates has introduced genuine price discovery into the bond market.

These policy changes reflect evolving domestic conditions. Wage growth has strengthened, inflation has become more persistent, and corporate pricing behaviour has adjusted. Japanese households are increasingly feeling the effects of rising living costs, weakening the case for permanently suppressed interest rates.

Higher domestic yields help narrow interest rate differentials and slow capital outflows — effectively undermining the economic logic of the carry trade.

Although Japanese yields remain low in absolute terms, even modest increases carry outsized consequences due to Japan’s central role in global funding markets.

The most immediate impact is on the yen carry trade itself. Rising Japanese yields compress interest rate differentials, increase FX hedging costs, and reduce the risk-adjusted attractiveness of foreign assets — particularly US Treasuries — for Japanese institutional investors.

Japan is the largest foreign holder of US Treasuries, and any sustained reduction in demand could trigger a sell-off in Treasuries. This would push US yields higher and bond prices lower, with ripple effects across global markets.

Spillover Effects Across

The unwinding of the carry trade extends well beyond bonds. Reduced participation by Japanese investors in global bond markets has pushed long-term yields higher and bond prices lower worldwide, tightening financial conditions across asset classes. Higher discount rates will weigh on equity valuations especially growth-oriented stocks, raising the risk of broader market pullbacks; while in foreign exchange markets, fewer incentives to short the yen have increased volatility and put pressure on high-yield currencies. Tighter global liquidity has also led to wider credit spreads, reflecting increased risk aversion, and has created valuation headwinds for yield-sensitive real assets and alternatives such as real estate and cryptocurrencies. At the same time, rising US Treasury yields leads to higher mortgage rates, straining housing affordability and dampening activity in housing markets.

You may assume no impact if you hold no direct Japanese assets. However, investments denominated in US dollars remain deeply interconnected with global capital flows.

Exposure to US Treasuries, global bonds, and international equities means your portfolio is indirectly affected by shifts in Japanese policy and the potential unwinding of the carry trade.

To mitigate potential fallout, investors, especially those heavily concentrated in US dollar assets, should reassess their global exposure and sensitivity to rising interest rates, while scaling back allocations to rate-dependent sectors such as financials, consumer discretionary, and real estate. Portfolios can be made more resilient by tilting towards defensive sectors and companies with strong balance sheets, limiting exposure to long-duration global bonds, and increasing allocations to real assets and hedges such as gold and silver. At the same time, closely monitoring key indicators — including US Treasury yields, major equity indices, and the USD/JPY exchange rate — can help investors respond more proactively to shifts in market conditions.

Japan’s policy shift does not signal an imminent crisis, but it does mark the end of a defining chapter in global finance. In a world where Japan no longer exports abundant cheap capital, funding costs matter again, and volatility is likely to remain elevated.

Investors would be well advised to engage proactively with their investment managers to reassess portfolio positioning and develop strategies to navigate the evolving global landscape shaped by the unwinding of the yen carry trade.

Denise Marshall-Miller is the assistant vice-president, global markets and digital asset trading at VM Wealth Management Limited. She has over two decades of experience in financial services, with a specialised focus on trading, asset management, and deal structuring.