“The $0.0065 Barrier Falls”: BOJ Tightening and Yen Carry Trade Unwind Fuel Sharp Yen Rebound, Emerging as Key Variable for U.S. Monetary Policy

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The yen has begun tracing a pronounced upward trajectory. Expectations of another interest rate increase by the Bank of Japan (BOJ) are spreading, strengthening prospects for a narrower U.S.–Japan interest rate differential, while signs are emerging that investors are unwinding the yen carry trade that has long underpinned the currency’s weakness. Markets predict that the yen’s appreciation could accelerate further. This is because the administration of U.S. President Donald Trump continues to press the Federal Reserve (Fed) relentlessly for interest rate cuts, applying the brakes to its monetary tightening campaign.

Yen’s Dollar Value Surges

According to a report by the Nihon Keizai Shimbun (Nikkei) on the 8th local time, the yen’s value in the Tokyo foreign exchange market briefly rose to approximately $0.0066 in morning trading before settling at around $0.0065 in the afternoon. This marked its strongest level since February. The yen had remained weak for an extended period this year. Its value fell to around $0.0063 in late April, the weakest level recorded since 1990, prompting the Japanese government and the BOJ to conduct large-scale yen-buying and dollar-selling interventions between late April and early May. The currency rebounded to approximately $0.0066 immediately after the intervention, but soon resumed its decline and slipped below $0.0063 again in late June.

The yen continued trading near $0.0063 in July and sank to around $0.0061 toward the end of the month. The Japanese government intervened in the foreign exchange market again in late July, and the United States joined efforts to defend the yen on July 31. According to Japan’s Ministry of Finance, Japanese authorities deployed a total of approximately $101.3 billion in the foreign exchange market over the roughly one-month period from July 30 to August 26. The large-scale intervention lifted the yen to around $0.0064, although it failed to reach approximately $0.0066. The situation reversed this month, however, as the yen began appreciating rapidly. Nikkei assessed that the currency had “breached the $0.0065 barrier that it had failed to overcome even during the Japanese foreign exchange authorities’ yen-buying interventions in late April through May and again in July.”

Expectations of a Japanese Policy Rate Increase

The yen’s rapid appreciation reflects the growing likelihood of a Japanese policy rate increase. The BOJ raised its policy rate to 1.0% at its June meeting before leaving it unchanged in July. Calls for another increase, however, had already emerged when the decision to hold rates steady was made. Policy Board member Hajime Takata was the only official to oppose the decision at the July meeting, arguing that the rate should be raised by 0.25 percentage point to counter upside inflation risks. BOJ Deputy Governor Ryozo Himino subsequently said on the 27th of last month that “inflation exceeding the target could adversely affect the economy” and that “interest rates need to be raised in a timely manner to prevent the response to inflation from falling behind.” His recommendation was that the BOJ should pay closer attention than before to upside inflation risks as underlying inflation approaches the central bank’s 2% target.

Recent Japanese economic indicators have also reinforced expectations of a rate increase. Japan’s real gross domestic product (GDP) expanded by 0.4% in the second quarter from the preceding quarter, equivalent to annualized growth of 1.4%. Real wages in July, released on the same day, rose 2.4% from a year earlier, marking their largest increase since May 2021. The figures suggest that the Japanese economy and households retain some capacity to absorb the burden of higher interest rates. Markets are therefore effectively treating a 0.25-percentage-point increase in the policy rate at the BOJ’s September meeting as their baseline scenario, while some observers are even discussing the unusual possibility of a 0.5-percentage-point hike.

Table 1. Effects of BOJ Policy Rate Increases on the Yen’s Value

How the Yen Carry Trade Works

The BOJ’s tightening campaign is a key catalyst for yen appreciation. Japan has maintained an ultralow interest rate policy for an extended period, leaving a wide interest rate differential with the United States and other major economies. This has fueled the proliferation of yen carry trades, in which investors borrow yen at relatively low funding costs, convert the proceeds into higher-yielding currencies such as the dollar and invest in overseas financial assets. This trading structure has exacerbated the yen’s weakness because investors must first sell the yen and purchase the dollar or another target currency to execute the strategy.

A BOJ rate increase would undermine the very premise of the yen carry trade. Higher funding costs in Japan and rising yields on yen-denominated assets reduce the expected return from borrowing yen to invest in higher-yielding overseas assets. If expectations spread that the BOJ will continue raising rates, investors will have even less incentive to sell yen and hold foreign assets. When yen carry trade investors unwind their positions in response to these market conditions, they must dispose of their overseas assets, sell dollars and repurchase yen. In effect, the existing pattern of selling yen and buying dollars moves into reverse.

Unwind Already Taking Shape

Clear signs of a yen carry trade unwind have already emerged in the foreign exchange market. According to data released by the U.S. Commodity Futures Trading Commission (CFTC) on the 14th of last month, leveraged funds’ short positions in the yen fell 6.5% over the week from August 5 to 11, reaching 59,526 contracts. When the period is extended to include the aftermath of the coordinated U.S.–Japan intervention to defend the yen in late July, the relevant short positions have declined by more than half. Since the yen’s value broke above $0.0065, not only leveraged funds but also real-money investors, including pension funds and asset managers, have begun reducing their short exposure to the currency.

Potential repayment demand arising from yen-funded positions is also substantial. According to an analysis of Bank for International Settlements (BIS) data by global investment bank Jefferies, cross-border yen borrowings reached an all-time high of approximately $2.37 trillion as of March this year. If demand for yen purchases expands as investors unwind these borrowing positions, appreciation pressure on the currency could intensify further. Signs of capital repatriation are also evident in Japanese investors’ transactions in foreign bonds. According to Reuters, Japanese investors recorded net sales of more than $19.7 billion in foreign bonds from the beginning of this year through the 22nd of last month. The growing relative appeal of Japanese government bonds has begun driving a visible shift in capital from overseas assets to domestic ones.

Discord Between the Fed and the Trump Administration

The yen’s appreciation is expected to continue for some time. While Japan is accelerating monetary tightening and raising its policy rate, friction persists within the United States over the appropriate direction of the benchmark rate. President Donald Trump has repeatedly demanded interest rate cuts even as the Fed focuses on the need for further rate increases. On the 4th, he wrote on the social media platform Truth Social, “Great employment numbers were just announced,” urging the Fed to “lower interest rates to the lowest level in the world now that America’s credit has strengthened.” He continued, “If rates are not lowered, we will stop trading with countries with which we run deficits,” adding that “the Supreme Court strongly recognized in its foolish and costly tariff ruling that the president has the absolute authority to do so.”

U.S. Vice President J.D. Vance has recently joined President Trump in publicly advocating lower rates. Asked during a White House press briefing on the 3rd about the Trump administration’s position on recent volatility in the U.S. Treasury market, Vance replied, “It is clear that the president is deeply focused on interest rates.” He explained, “One of the principal reasons the president considers interest rates so important is that he wants Americans to be able to buy homes,” adding that “when interest rates rise, borrowing costs rise as well.” He continued, “Based on recent inflation and consumer price index (CPI) data, we are convinced that lowering rates would be the appropriate and responsible course for the Fed,” and added, “We are doing many things to bring rates down, but it would be helpful if we could receive a little assistance from the Fed.”