The Yen Is Moving Before the Bank of Japan Raises Rates
The yen reached a seven-month high against the US dollar on 8 September as traders increased bets that the Bank of Japan will raise interest rates next week. Markets put the probability of a 25-basis-point increase to 1.25 per cent at about 97 per cent.
The Bank of Japan has not made that decision yet, but traders have already repositioned around it. Cross-border yen borrowing, a rough proxy for the scale of the carry trade, reached a record JPY 360 trillion in March. Investors borrow yen at relatively low rates, convert the money into another currency and buy higher-yielding assets elsewhere.
A fund that borrows JPY 1 billion, converts it into dollars and buys US assets earns the difference between the return on those assets and its Japanese funding cost. The trade works while that income exceeds financing and currency losses. Yen appreciation raises the cost of buying back the currency needed to repay the loan, and a large enough move removes the interest-rate advantage altogether.
Leverage leaves less room to absorb that move. A fully funded investor can hold an asset through a currency loss. A leveraged fund may face a margin call first, forcing it to sell positions even when the underlying investment has little connection to Japan.
Markets saw that mechanism in 2024. A Bank of Japan rate increase helped drive the yen higher and forced investors out of leveraged carry trades, sending selling through global markets. Assets outside Japan fell because investors had financed them with yen.
September 2026 looks different because investors already expect the central bank to tighten. The Bank of Japan meets on 17 and 18 September, and traders have pushed the yen higher before the meeting rather than waiting for Governor Kazuo Ueda and his colleagues to announce a decision. The currency strengthened to 152.89 per dollar on 8 September after trading near 160 less than a week earlier.
Buying yen solely because the Bank of Japan looks likely to raise rates therefore means buying into an expectation that most of the market already shares. If policymakers deliver the expected 25 basis points without signalling faster tightening, investors who bought the currency beforehand may take profits. A decision to leave rates unchanged would force a much larger repricing.
Foreign-exchange traders price the difference between what markets expected and what policymakers actually deliver. A rate increase does not automatically strengthen a currency when investors had already positioned for it.
Japanese investors are also reconsidering why they hold so much money abroad. For years, low domestic yields pushed banks, insurers and pension funds towards foreign bonds and other overseas assets. Japanese government bond yields have now risen enough to make domestic assets more competitive. Fitch said higher yields could keep more institutional money in Japan, while Reuters reported that the 10-year government bond yield has been trading near its highest level in decades.
An insurer selling foreign bonds and bringing the proceeds home creates demand for yen without unwinding a conventional leveraged carry trade. Enough repatriation would reinforce the pressure already coming from investors closing short-yen positions.
Oil adds another complication. Brent crude has moved towards $100 a barrel as conflict in the Middle East disrupts energy markets. Japan imports most of the fossil fuels it consumes, so higher oil prices increase import costs and feed into domestic inflation. Yen appreciation offsets part of that increase by making dollar-priced energy cheaper in local currency terms.
The Bank of Japan therefore meets with domestic yields rising, the yen strengthening and imported energy costs climbing at the same time. Traders holding yen-funded positions have to account for all three because each one changes the economics of borrowing cheaply in Japan and investing elsewhere.
A carry trade earning a few percentage points a year has limited protection against a currency that moves several percentage points in days. Reuters reported that the yen gained nearly 5 per cent against some major carry-trade currencies in early September alone.
JPY 360 trillion of cross-border yen borrowing will not disappear after one Bank of Japan meeting, but the currency has already changed the cost of maintaining part of it. Investors who borrowed yen when it was weaker now need more dollars, pesos or other currencies to buy those yen back.
