Policy Gap And Carry Trade Build
This widening policy gap supported the build-up of yen-funded carry trades. The trade-weighted yen has fallen by about 23% since the 2022 energy shock, with more than half of that decline occurring after volatility peaked in April 2025, when Trump announced Liberation Day tariffs. A rise in risk aversion linked to the Middle East conflict could lead to a reversal in these carry trades. Such a squeeze could drive a counter-trend yen rebound. The Japanese yen has not strengthened despite the recent spike in market volatility, with its trade-weighted index staying near its lows for the year. Net short JPY positions among speculative traders recently hit a multi-year high, reaching over $15 billion according to the latest CFTC data. This indicates a very crowded trade betting against the yen, even as market fear gauges rise. We remember how the yen rallied sharply on the last two occasions when FX volatility spiked, first in April of last year and again during the summer of 2024. In that April 2025 episode, for instance, the USD/JPY pair fell by nearly 5% in under a week as traders rushed to close out their carry positions. History suggests that when risk aversion truly takes hold, the yen tends to benefit as a safe-haven currency.Positioning And Hedge Ideas
This vulnerability began after the 2022 energy shock, when the Bank of Japan kept interest rates low while other central banks hiked aggressively. This wide interest rate differential, which still sits above 450 basis points with the US, encouraged traders to borrow cheaply in yen to invest in higher-yielding currencies. This massive build-up of JPY-funded carry trades has contributed to the yen’s 23% decline since that time. The primary risk now is a violent reversal if the current geopolitical shock intensifies, triggering a squeeze on those crowded positions. Derivative traders should therefore consider purchasing out-of-the-money JPY calls or USD/JPY puts. These options provide a low-cost way to position for a sudden and powerful counter-trend rally in the yen, protecting against a sharp unwinding of the carry trade. Create your live VT Markets account and start trading now.
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