The Waning Power of the USD/JPY Carry Trade: Is the Yen's Repricing Inevitable?

The USD/JPY carry trade, a cornerstone of global capital flows for decades, is facing a critical juncture in 2025. Historically, this strategy-borrowing in low-yielding Japanese yen to fund higher-yielding U.S. dollar assets-thrived on stark interest rate differentials. However, central bank policy shifts, narrowing yield spreads, and mounting yen appreciation risks are now challenging its sustainability. As the Bank of Japan (BOJ) signals a potential rate hike and the Federal Reserve (Fed) navigates a cautious rate-cutting path, the yen's repricing appears increasingly inevitable, with profound implications for global markets.

Central Bank Policy Divergence: A Tipping Point

The BOJ's recent policy tightening has pushed Japan's 10-year government bond yield to a 1.95% 18-year high, yet the yen remains unusually weak against the dollar. This divergence suggests that markets anticipate tighter BOJ policy but do not expect significant yen appreciation, leaving the currency vulnerable to sudden revaluation. Meanwhile, the Fed has maintained high interest rates, with a 3.75% benchmark rate as of December 2025. A scenario where the Fed adopts a dovish stance while the BOJ continues tightening could narrow the U.S.-Japan yield differential rapidly, increasing pressure on the yen carry trade.

The BOJ's December 2025 rate hike to 0.75%-a 25-basis-point increase-marks a pivotal shift from its long-standing ultra-loose monetary policy according to reports. This normalization, coupled with the abandonment of yield curve control (YCC) in March 2024, signals a structural break in Japan's monetary framework. Conversely, the Fed's rate cuts have reduced the U.S. benchmark rate to 3.75%, narrowing the yield spread to 220 basis points from 350 basis points earlier in 2025. Such a compression erodes the profitability of carry trade positions, incentivizing investors to reassess their exposure.

Historical Precedents and Intervention Risks

The USD/JPY carry trade's fragility is further underscored by historical central bank interventions. Japan's interventions in October 2022, which cost up to ¥9.2 trillion ($60.78 billion) to stabilize the yen near 152 per dollar, highlight the government's willingness to act unilaterally. Earlier episodes, such as the ¥35 trillion ($300 billion) spent during the 1997–1998 Asian financial crisis, demonstrate the scale of resources allocated to manage yen volatility. These precedents suggest that the BOJ or Japanese government may intervene again if the yen weakens beyond tolerable levels, potentially triggering abrupt market corrections.

Empirical research also complicates the efficacy of such interventions. A 2013 study in the Journal of Asian Economics found that BOJ interventions increased USD/JPY exchange rate volatility, with mixed effects on jump volatility depending on intervention frequency and size. This implies that while central banks aim to stabilize exchange rates, their actions may inadvertently amplify short-term fluctuations, heightening risks for carry trade participants.

Market Positioning and Forward Rate Analysis

Recent Commitments of Traders (COT) reports reveal speculative positioning trends. As of November 2025, non-commercial traders held 188,404 long JPY futures contracts versus 68,189 short positions, indicating a bullish bias. Commercial traders, however, maintained a more balanced stance, suggesting hedging activity rather than directional bets. This divergence underscores market uncertainty about the yen's trajectory.

Forward rate analysis further complicates the outlook. MUFG Bank forecasts a Q4 2025 USD/JPY rate of 152.00, while technical analysis from Forex.com identifies resistance near ¥154–155 and support at ¥153. Analysts like Christopher Lewis argue that the yen could test ¥160 on pullbacks, driven by persistent U.S. dollar strength and Japan's quantitative easing according to technical analysis. Yet, structural factors-such as Japan's current account surplus and global demand for yen-based liquidity-may temper sharp revaluations.

The Inevitability of Yen Repricing

The yen's repricing appears increasingly inevitable, but its pace and magnitude depend on central bank coordination and market dynamics. A stronger yen would raise funding costs for carry trade positions, potentially triggering a self-reinforcing unwind. However, structural investment flows and declining hedging costs due to Fed rate cuts may mitigate large-scale repatriation of funds into Japan.

Central bank communications in late 2025 reinforce this tension. The BOJ's measured rate hikes and the Fed's cautious rate cuts suggest a gradual narrowing of the yield differential, avoiding abrupt market shocks. Yet, if the yen appreciates rapidly-say, to 148 per dollar as some forecasts suggest-the costs of repaying yen-based loans could erode carry trade profits, spilling over into equity and emerging market volatility according to market analysis.

Conclusion

The USD/JPY carry trade's waning power reflects a confluence of policy normalization, narrowing yield spreads, and yen appreciation risks. While the BOJ's tightening and the Fed's easing create a headwind for carry trade profitability, the yen's repricing is not a binary event but a spectrum of outcomes shaped by central bank interventions, market positioning, and global capital flows. Investors must remain vigilant to the fragility of leveraged positions and the potential for sudden volatility, as the yen's journey from a "ticking time bomb" to a recalibrated currency gains momentum.