Why a quarter-point Japanese rate rise shook world markets in 2024

On Monday 5 August 2024, Japan’s main stock index had its worst day since 1987. The trigger looked small: a quarter-point rate rise in Tokyo and one weak US jobs report. The reaction was large because of a trade that had quietly grown for years.

What a carry trade is

A carry trade has two legs. An investor borrows in a currency where interest rates are very low. They then convert the money and invest it where returns are higher, for example in US dollar deposits, Mexican government bonds or US technology shares. The profit is the gap, or “carry”, between what they pay and what they earn.

The Bank for International Settlements (BIS), owned by central banks, notes that many such trades use currency derivatives such as forwards, FX swaps and options rather than plain loans [1]. These contracts need little cash up front, so they allow high leverage.

The trade works while exchange rates stay steady. The danger is that the borrowed currency rises. If the yen gains 6% against the dollar, a dollar asset bought with borrowed yen loses about 6% of its value in yen terms, which can wipe out many months of carry. BIS staff likened it to “picking up nickels in front of a steamroller” [1].

Why the yen was the classic funding currency

For most of the past decade, borrowing yen cost almost nothing. On 29 January 2016, the Bank of Japan (BoJ) introduced a negative interest rate of minus 0.1% on part of the reserves banks hold with it [2]. On 21 September 2016, it added “yield curve control”, a pledge to buy government bonds so that 10-year yields stayed around zero [3].

As other central banks raised rates to fight inflation after the pandemic, the gap between yen funding costs and returns elsewhere widened. The BIS found that carry trade returns, measured against expected currency swings, peaked in the first quarter of 2024 [1].

The BoJ ended negative rates and yield curve control on 19 March 2024, setting its short-term rate at around 0% to 0.1%, and said accommodative conditions would continue for the time being [4].

The decision of 31 July 2024

On 31 July 2024, the BoJ raised its target for the overnight call rate (the rate banks charge each other for one-day loans) to around 0.25%, effective 1 August [5]. It also set out a plan to cut its monthly government bond purchases to about ¥3 trillion by early 2026, and said it would keep raising rates if its forecasts came true [5]. The vote was 7–2. Board members Nakamura Toyoaki and Noguchi Asahi wanted to wait for more data [5].

The BIS said markets saw the move as “hawkish”, meaning more inclined to tighten than expected, while the US Federal Reserve seemed cautious about cutting rates [1]. On 2 August, weaker-than-expected US labor data revived recession fears, and the S&P 500 fell 1.8% [1].

5 August 2024

When Tokyo opened after the weekend, Japan became the centre of the selling. The Nikkei 225 fell 4,451.28 points, or 12.4%, to 31,458.42, its largest one-day fall in points on record [6]. The broader TOPIX index lost 12% [1]. The S&P 500 fell another 3.0%, and the VIX, a measure of expected US share-price swings, briefly rose above 60 in off-hours trading [1].

Between 1 and 5 August, the yen rose 6.0% against the dollar. The Swiss franc, another funding currency, rose 3.4% [1]. Margin calls, demands that traders post more cash when positions lose value, forced further sales [1].

By 9 August, the S&P 500 had regained that week’s losses and the TOPIX most of its own [1].

A small rate rise did not cause the sell-off on its own. It changed the odds on a crowded, leveraged bet, and the closing of that bet did the rest.

Why the Mexican peso was caught up

Emerging-market currencies with high interest rates were popular places to invest borrowed yen. When traders closed their positions, they sold those currencies to repay yen. Between 1 and 5 August, the Mexican peso fell 6.1% against the dollar, the largest drop among high-yielding currencies, followed by the Brazilian real (2.5%) and the South African rand (2.1%) [1].

The BIS noted the peso had already fallen in June 2024 amid political uncertainty in Mexico, and that Latin American currencies lost much of their appeal to carry traders as rate gaps narrowed [7]. Some Asian currencies, including the offshore Chinese renminbi and the Malaysian ringgit, rose instead [1].

How big was the trade?

Nobody knows exactly, because much of it sits in over-the-counter derivatives that are not publicly reported. The BIS combined several measures and arrived at a “rough middle ballpark” of ¥40 trillion ($250 billion) before the sell-off. It said that figure, if anything, understates the total because of gaps in the data [1]. The underlying measures ranged from about ¥2 trillion in speculative yen futures to more than ¥80 trillion in yen bank claims on borrowers in offshore centres such as the Cayman Islands [1].

The International Monetary Fund (IMF) took a similar approach in October 2024. It said yen borrowed by non-residents could serve as a guide to an upper bound. Banks’ yen lending to non-bank borrowers outside Japan had reached about ¥41 trillion [8].

Some private-sector estimates were higher. UBS strategist James Malcolm put the dollar-yen carry trade at no less than $500 billion at its peak, and said only about half had been unwound by 6 August. Shaun Osborne of Scotiabank also judged that speculators had cut their short yen positions by about half [9].

Differing views on the cause

The central banks put most weight on market structure. The BIS argued that the US jobs data were hardly a clear sign of recession. In its view, markets overreacted because leverage had built up during a long period of low volatility [1]. The IMF said hedge funds and other non-bank investors had amplified the turmoil and deserved closer supervisory attention [8].

Others pointed more directly at Tokyo. Tomochika Kitaoka, chief equity strategist at Nomura Securities, told Reuters that investors grew nervous after the rate rise because they doubted Japan’s economy was strong enough to justify it [6].

The BoJ itself stepped back. On 7 August 2024, Deputy Governor Uchida Shinichi said large positions built on a weak yen were being unwound. He also said the Bank “will not raise its policy interest rate when financial and capital markets are unstable” [10]. He added that, unlike in the United States and Europe, Japan was not at risk of falling behind the curve if it paused [10].

What the BoJ did next

The pause did not last. The BoJ raised its policy rate to around 0.5% on 24 January 2025 [11], to 0.75% on 19 December 2025 [12] and to 1.0% on 16 June 2026 [13]. On 18 September 2026, it moved to around 1.25% by a 7–2 vote; the dissenters, Asada Toichiro and Sato Ayano, said the economy did not yet justify it [14]. On 30 October 2026, the Board held at 1.25% by 8–1, with Takata Hajime proposing 1.5% [15]. The Bank says it will keep raising rates if its forecasts hold, and is watching the weak yen as a source of price pressure [14].

The BIS warned in 2024 that only part of the yen-funded positions had been closed and that some were already being rebuilt [1]. At 1.25%, Japan’s policy rate remains low by international standards, so the incentive to borrow yen has narrowed rather than disappeared.

What to watch

• 17–18 December 2026: next BoJ Monetary Policy Meeting [16].
• 21–22 January 2027: BoJ meeting, with an updated Outlook Report on growth and inflation [16].
• Yen-funding data: the BIS publishes its banking statistics and Global Liquidity Indicators quarterly, which show how much yen is lent to borrowers outside Japan.