- Michael Allison, CFA
- 4 days ago
- 3 min read
By Michael Allison, CFA
A “Normal” Japan and the Unwinding of the Carry Trade
This week’s Chart shows that following the global inflation scare of 2021-22, long term interest rates in Japan have continued to rise, but unlike in other countries, at an accelerating pace.
Some say this is due to Japan’s reemergence as a “normal” economy which is being framed as a curiosity: an end to deflation, a long-overdue policy shift, a local story.
That framing misses the point. I believe that’s really happening is the dismantling of a 30-year global funding regime, i.e. the so-called carry trade, and that should matter deeply to anyone managing portfolios for investors approaching or already in retirement.
Carry Me…
For decades, Japan’s zero-rate policy quietly subsidized global risk-taking. The yen wasn’t just a currency. Yen-based debt was capital: cheap, abundant, and reliably available. That mattered because it helped suppress volatility, compress yields, and mitigate drawdowns, conditions that retirement portfolios came to implicitly rely on.
To see why, let’s consider how the yen carry trade has historically worked.
One version was conservative but massive in scale: borrow yen at near-zero rates, hedge the currency, and buy higher-yielding U.S. Treasuries or investment-grade credit. Japanese institutions did this relentlessly. The result? Persistent demand for global bonds and downward pressure on yields.
Another version was more aggressive: borrow yen, don’t hedge the currency, and deploy the capital into equities, high yield bonds, emerging markets, or, more recently, tech stocks and crypto. As long as the yen stayed weak and volatility stayed low, leverage paid off. And for years, it did.
That trade is now starting to break down.
Japan’s policy rate is near 0.75%, long-term yields are rising as the Chart shows, and global rate differentials are narrowing just as U.S. and European central banks approach the downshift phase of their cycles.
Deleveraging By Another Name
The carry is evaporating. When carry disappears, leverage doesn’t gently fade—it unwinds.
This matters for retirement portfolios because many of the assumptions embedded in “balanced” allocations were built in a world where:
Volatility was structurally suppressed
Global liquidity flowed one way
Drawdowns were shorter and recoveries faster
Those assumptions are fragile in a post-carry-trade world.
As yen-funded leverage retreats, three risks rise simultaneously:
Higher volatility
Carry trades dampen volatility on the way in and amplify it on the way out.
Correlation creep
When leverage unwinds, diversification often fails at the worst possible time. Assets that looked uncorrelated suddenly move together.
Valuation compression
Many assets, especially equities, benefited from a global discount rate artificially lowered by carry flows. Remove the subsidy, and multiples could come under pressure.
Think Different(ly)
This doesn’t mean markets will collapse. It means the tailwinds quietly supporting traditional portfolios could be weaker, while left-tail risks could become stronger.
For retirement-oriented investors, the takeaway isn’t tactical, it’s structural.
Risk management can’t continue to rely on backward-looking volatility measures or static 60/40 logic. It has to acknowledge that a major shock absorber in the global system is being removed.
Japan being “normal” again is not a footnote. It’s a reminder that regimes change, and retirement portfolios built for the last one will need protection for the next.
Sources: RSM US, LLP; World Economic Forum, Financial Times, The Overshoot
Interested in reading more of Mike's weekly newsletters? Click below to view The Sunday Drive.
