In early September, top foreign exchange experts at Japan's biggest banks were flooded with calls from investors and regulators regarding the size and potential unwinding of the yen carry trade. The honest admissions — "nobody exactly knows" and "a lot closer than we would like" — offered little comfort. This strategy, where hedge funds borrow the stable yen for low-cost financing to fund global bets, has persisted for nearly 30 years, exploiting interest rate differentials.

With the Bank of Japan benchmark rate recently rising above 1% for the first time since 1995, investors fear spectacular market spasms across emerging debt, Nasdaq stocks, and cryptocurrencies. Masayuki Nakajima, a senior strategist at Mizuho Bank, warns the yen carry trade is a main potential source of market instability. The trade's current value may far exceed $2tn, making it potentially the biggest ever.

Regulators are particularly concerned the cheap yen may be anchoring US Treasuries and inflating AI-related shares. US Treasury Secretary Scott Bessent warned of disorderly markets triggering forced unwinds, prompting a historic joint Japan-US intervention in late July to support the currency. However, further hawkish pressure from the US and potential Bank of Japan rate hikes to 1.25% could lay the conditions for the very unwind policymakers are trying to avoid.

Strategists now view the danger of an unwind as a far more pressing threat than weeks prior, noting the trade now fuels not just leverage but broader real economic strategy.