Author: Chief Analyst of HashKey Group Jeffrey Ding
Crossroads of the Market
In August 2026, the global financial markets are standing at a historic crossroads. The Bank of Japan has raised interest rates consecutively over the past year and a half, pushing the policy rate from a negative range to 0.75%, the highest level since September 1995. Meanwhile, under the dual pressure of falling inflation and an economic slowdown, the Federal Reserve has lowered rates from their peak to 3.75%. The directional divergence in monetary policy between Japan and the United States has narrowed the interest rate differential, which had once reached a staggering 560 basis points, down to about 300 basis points in just two years. For global capital markets, this change in numbers signifies the end of a financial paradigm that has lasted for thirty years.
The yen carry trade, a vast system of borrowing cheap yen to invest in high-yield dollar assets, is collapsing. Amid the turbulent retreat from this financial market, a foreign international monetary authorities repurchase tool known as FIMA is held with "Dunkirk-like" expectations by the market. Is this merely a short-term policy tool to save the yen, or is it the final act providing cover for an orderly withdrawal from a thirty-year carry trade?
The True Face of Carry Trade: A Trillion-Dollar Dam
To understand the urgency of the current dilemma, one first needs to recognize the true scale and structure of the carry trade. By the end of 2024, the balance of yen-denominated loans by the Bank of Japan to non-bank entities abroad will reach 310 billion dollars, which is the narrowest definition. However, when including re-mortgaged, multi-layered leveraged funds, and various derivative positions, the broader estimate becomes significantly larger: ranging from 9.3 trillion dollars to 19.2 trillion dollars, equivalent to the combined GDP of Japan, Germany, and the United Kingdom.
This massive pool of funds is not evenly distributed. Prior to 2023, the classic carry trade operation was to borrow yen, buy U.S. Treasury bonds, with interest rate spread as the core profit source and exchange rate gains as a supplement. However, with the Fed's aggressive rate hikes pushing U.S. bond yields higher and the continued depreciation of the yen forming a one-way expectation, there has been a fundamental strategic evolution in the carry trade post-2023. An increasing number of hedge funds have abandoned the traditional arbitrage model, opting instead to borrow yen to invest in U.S. tech stocks, particularly those related to artificial intelligence. Data from Goldman Sachs shows that investments in the AI field now account for over 1% of U.S. GDP, with a considerable proportion of the funding supported by yen financing. This means that carry trade has evolved from simple fixed-income arbitrage into an important pillar for the valuation of global risk assets, particularly tech stocks.
This structural change is crucial. It indicates that when the yen rapidly appreciates and triggers forced liquidations, what will be sold off will not only be U.S. Treasury bonds, but also the most liquid and highly valued tech stock positions. This explains why the market's sensitivity to a yen appreciation has reached a historic high. The unwinding of the carry trade is not a localized adjustment but a chain reaction of global deleveraging, whose shockwaves will permeate every asset class with ample liquidity.
The FIMA Mechanism: A Stopgap at the Cost of Money Printing
It is against this backdrop that FIMA has entered the public's consciousness. FIMA, or the Foreign and International Monetary Authorities Repo Facility, allows foreign central banks and monetary authorities with accounts at the New York Federal Reserve to use their holdings of U.S. Treasury securities as collateral to borrow U.S. dollars from the Fed. The operation occurs as a buy-back transaction, typically for overnight or seven calendar days. Currently, the cap on outstanding loans for each counterparty is 60 billion dollars. For Japan, which holds about 1.1 trillion dollars in U.S. Treasury bonds, this means that the Japanese Ministry of Finance can convert these held U.S. bonds at the New York Federal Reserve into usable dollar liquidity without having to sell even a single bond on the open market.
This constitutes the core contradiction of the entire story. In traditional exchange rate interventions, if a country's central bank needs to sell dollars and buy domestic currency to support its currency rate, it typically needs to use its foreign exchange reserves. However, if reserves are insufficient, it can only sell off overseas assets to raise funds. For Japan, selling U.S. Treasury bonds means becoming a net seller in the Treasury market. Given that Japan is the largest overseas holder of U.S. Treasury bonds, large-scale sales will lead to a crash in bond prices and a surge in yields. The 30-year Treasury yield has surged to about 5.33% (as of August 19, 2026), marking its highest level since 2007, which already indicates the sensitivity of the market.
The ingenuity of FIMA lies in that it allows Japan to acquire dollar ammunition without disturbing the Treasury market. The Japanese Ministry of Finance collateralizes its Treasury bonds with the Fed, and the Fed creates dollars out of thin air to lend to Japan. Japan then sells these dollars in the forex market to buy yen, thereby pushing up the value of the yen. The U.S. gains time and avoids an orderly collapse of the Treasury market. Japan gains ammunition to intervene in the exchange rate without depleting its own reserves. It sounds like a win-win situation.
However, this operation has a crucial and often overlooked cost. The dollars created by the Fed do not vanish after they are sold by the Japanese Ministry of Finance. They flow into the global financial system. The counterparts accepting these dollars include international commercial banks, hedge funds, and other financial institutions. Ultimately, they settle as part of global dollar liquidity. This is essentially indistinguishable from quantitative easing. The Fed's balance sheet will expand in tandem with the increase in FIMA repo scale, dollar supply increases, the dollar weakens, and inflationary pressures rise. As Arthur Hayes stated in a recent article, the "sucker" in this operation is the American taxpayer; Japan owes this money to American taxpayers and, for political reasons, will never pay it back, as this is purely a money-printing behavior.
From Zero Interest Rates to Global Arbitrage Field
The formation of the yen carry trade is rooted in Japan's unique monetary environment that has lasted for thirty years. After the asset bubble burst in the early 1990s, the Japanese economy fell into a balance sheet recession. To stimulate the economy and escape deflation, the Bank of Japan has embarked on unprecedented ultra-loose monetary policy. In September 1999, Japan lowered its policy interest rates to zero. Since then, apart from two brief windows of rate hikes, the Bank of Japan has maintained the lowest interest rate level among the major economies globally for nearly thirty years. In January 2016, Japan further lowered the policy interest rate to -0.1% in the negative interest rate range and introduced yield curve control in September of the same year.
This extreme loose monetary policy provides the core soil for carry trading. Almost zero financing costs. The yen, with low costs, high liquidity, and a mature financial market, became the world's most mainstream funding currency. At the same time, interest rates in major economies represented by the U.S. have remained high over the long term, creating a sustained and massive interest rate differential between Japan and the U.S. When the interest rate spread exceeds the combined risk of exchange rate fluctuations and transaction costs, the carry trade is based on a sustainable profit basis.
The development of the carry trade has gone through several critical stages. In the late 1990s, Japanese interest rates rapidly fell, expanding the interest rate differential with the U.S., which initiated the initial rise of the carry trade. After 2002, Japanese interest rates stayed low again, with the interest rate differential expanding further, leading to further expansion of the carry trade. However, the true leap occurred after the introduction of "Abenomics" in 2013. The quantitative and qualitative easing policies ushered Japan into an era of unlimited Treasury bond purchases, while the yen entered a decade-long depreciation channel. Meanwhile, U.S. interest rates began to rise, marking the official start of large-scale yen carry trades in the modern sense. Over the past thirty years, Japanese banks, households, and institutional investors have become the main forces behind the carry trade, which has evolved from simple arbitrage into an important component of global asset allocation.
Thirty years is enough time for the international financial market to develop a habitual and rigid demand for carry trading. A plethora of financial products, hedging strategies, and institutional portfolios are built upon this paradigm of "borrowing yen to buy dollar assets." This inertia means that the end of the carry trade cannot happen overnight, but it is precisely this inertia that means once the reversal occurs, its impact will far exceed any localized crisis.
Every Reversal Brings Huge Shock to the Market
Historically, each large-scale reversal of the carry trade has shocked global markets in the form of a crisis. During the 2007-2008 global financial crisis, as expectations for Fed rate cuts heightened, there was a massive retreat from carry trades, causing the dollar to plunge against the yen from 125 to 87, a drop of nearly 30%. In 2015, a reversal in the carry trade sparked another round of turbulence in international financial markets. In the wake of the COVID-19 pandemic in 2020, the global risk appetite reversed, and the liquidation of carry trades exacerbated market volatility.
The most recent instance—a "Black Monday" in August 2024—was the most alarming rehearsal. An unexpected rate hike by the Bank of Japan triggered massive forced liquidations of carry trades, causing the dollar to plunge against the yen by nearly 15% within three weeks, Japan's stock market plummeting 12% in a single day, and the S&P 500 index falling 3% in a single day, with the VIX volatility index briefly exceeding 60. The intensity of this turmoil has made global regulators aware that the unwinding of carry trades is no longer a localized event of a single market, but a potential catalyst for global systemic risk.
The logic behind each reversal is highly consistent: a yen appreciation triggers losses in carry trades, these losses force investors to liquidate risk assets, further driving up the yen, which triggers even more liquidations. This is a self-reinforcing cycle of踩踏, and each踩踏 is more severe than the last. This is because the scale of carry trading continues to expand, leverage continues to rise, and asset price valuations continue to swell. When this cycle begins to operate in reverse, its destructive power increases geometrically.
This Time is Really Different
Now, the three pillars supporting the existence of carry trades are crumbling simultaneously, which is an unprecedented situation in history.
The first pillar is Japan's low interest rates. In March 2024, the Bank of Japan announced its exit from negative interest rates and yield curve control. Thereafter, Japan raised rates three times in July 2024, January 2025, and December 2025, elevating the policy rate from -0.1% to 0.75%. Market expectations for further rate hikes by the Bank of Japan remain strong, with some institutions predicting a rise to 1% by the end of the year. This means that the nearly free yen financing costs of the past thirty years are being historically elevated. Borrowing yen is no longer zero but is approaching or even exceeding 1%, which is a fatal blow to carry trades dependent on thin interest rate spreads.
The second pillar is the U.S.-Japan interest rate differential. At the beginning of 2024, the U.S.-Japan interest rate spread peaked at 560 basis points. By the end of 2025, the Fed will have lowered rates to 3.75% while Japan increased rates to 0.75%, narrowing the spread to about 300 basis points. The systematic narrowing of this spread means that the profit margin for carry trades is being continuously compressed, while the risks of exchange rate fluctuations are rising simultaneously. When the interest rate spread is insufficient to offset exchange rate risks, carry trades transition from "guaranteed profits" to "high-risk gambling."
The third pillar is the expectation of yen depreciation. The continuous depreciation of the yen over the past thirty years has created a consensus expectation, effectively reducing the risk of exchange losses for carry trades. Going long on the dollar against the yen has become one of the "most crowded trades" in the market. However, now, with the dual effects of the Bank of Japan's rate hikes and the Fed's rate cuts, expectations for yen depreciation are being shattered. The dollar-yen exchange rate has fallen from over 160 to a level where the market is beginning to discuss that the fair value of the yen should be around 90. A yen that fluctuates both ways is deadly for carry traders. Because exchange gains and losses are no longer a stable positive source of income, but have turned into a highly uncertain risk variable.
The simultaneous occurrence of these three changes signifies that the inertia and rigidity of the carry trade demand formed over the past thirty years are being swiftly broken. The end of the carry trade is not a simple market fluctuation but a termination of a thirty-year financial paradigm. Any hopes of "waiting for the storm to pass and the carry trade to return" may underestimate the depth of this structural change.
How Funds Will Be Reallocated
After the carry trades unwind, how will funds flow? Which assets will benefit, and which will be harmed? The answer to this question needs to be viewed in stages.
The first stage is certain and is already happening. Carry traders are being forced to unwind, and the path is highly consistent: selling overseas assets, primarily U.S. tech stocks and U.S. Treasury bonds, to exchange for dollars, and then swap back for yen to repay yen loans. This process forms a positive feedback loop of yen appreciation and asset sales. Funds are being pulled back from around the world into Japan, making the Japanese stock market and Japanese government bonds the first recipients.
In this stage, U.S. tech stocks are under the most pressure. Hedge funds' positions that heavily borrowed yen to invest in tech stocks are being forcibly liquidated. This unwinding pressure represents the final stage of the current market correction, but before this, tech stocks will still face huge selling pressure. AI concept stocks that relied on cheap yen financing to support valuations over the past few years may face the most severe valuation reconstruction. U.S. Treasury bonds also face pressure, as funds previously used in carry trades to buy U.S. Treasury bonds are being withdrawn, while hedge funds that turned to shorting U.S. bonds post-2023 complicate the situation further.
The direction of the second stage will depend on which path the U.S. and Japan choose. If they choose the FIMA path, the Fed will need to create dollars out of thin air to provide loans to Japan. After these dollars are sold by Japan, they will flow into the global financial system, resulting in a flood of global dollar liquidity. In this case, Bitcoin and gold will be the biggest beneficiaries. The core argument of Arthur Hayes is that there is a clear positive correlation between the expansion of the Fed's balance sheet and the price of Bitcoin. Whenever the Fed injects more funds into the financial system, assets like Bitcoin typically rise. Similarly, gold benefits from the weakening of fiat currency credit, although it may be sold off initially due to liquidity squeezes as assets including gold are liquidated to meet margin requirements, but the mid- to long-term logic remains firmly bullish.
However, if the FIMA path fails or is insufficient to meet intervention demands, Japan will be forced to directly sell U.S. bonds to raise dollars, with drastically different consequences. A large sell-off of U.S. bonds would lead to a price crash and soaring yields, tightening global dollar liquidity, and putting pressure on risk assets across the board. This is the worst path and the outcome that the U.S. would prefer to avoid at all costs by choosing the FIMA route.
The U.S.-Japan Calculation: Why FIMA is the Only Choice
Among the three possible proposals, the FIMA path is the only option that maximizes the interests of both the U.S. and Japan. Proposal one is that the Bank of Japan raises rates significantly, which would cause huge unrealized losses on the Bank of Japan's balance sheet and could trigger massive forced liquidations of global carry trades. Remember how when the yen rose from 160 to 140 in July 2024, it led to more than a 10% drop in both the Nasdaq 100 index and the Nikkei index. Proposal two is that Japan directly sells overseas assets to repatriate yen, meaning "Japan Inc.," as one of the largest holders of U.S. securities, would transition from buyer to seller, directly destroying the U.S.'s reliance on its lavish stock and bond markets.
Only the FIMA path can raise the yen while avoiding a crash in the Treasury market. The core interest of the U.S. is to prevent Japan from selling U.S. bonds and avoid uncontrollable surges in Treasury yields. Japan's core interest is to gain the ability to intervene in its exchange rate without exhausting its own reserves. FIMA satisfies both demands at the cost of increasing the Fed's balance sheet and further weakening the dollar's credit.
The power to adjust the FIMA mechanism lies with the Foreign Currency Subcommittee of the Federal Open Market Committee, whose voting members include the FOMC Chairman, the FOMC Vice Chair and President of the New York Fed, and the Vice Chair of the Federal Reserve Board. This committee does not release meeting minutes or disclose voting records, and the outside world can only learn about the outcomes of its decisions. This opacity in its operations makes it challenging for the market to accurately forecast the timing and scale of FIMA expansions, forcing them to infer through price signals.
Once the yen reaches the target price level, will FIMA suddenly tighten? Analyzing from the perspective of maximizing U.S.-Japan interests, the answer is no. A sudden tightening would mean Japan loses its source of dollar ammunition, and if the interest rate spread issue has not been resolved, the yen will rapidly return to pre-intervention levels, rendering prior intervention investments wasted. More importantly, what the U.S. fears most is Japan being forced to sell U.S. bonds; as long as this risk has not been entirely eliminated, FIMA should remain available.
A more likely scenario is a gradual transition. FIMA moves from active use to standby deterrence, while the Bank of Japan's rate hikes take up the primary task of stabilizing the exchange rate. The length of this transition period depends on the pace of the Bank of Japan's rate hikes and the speed at which the U.S.-Japan interest rate spread narrows. FIMA has been a long-term mechanism of the Fed since July 2021; it will not disappear but will rather return to a usage balance close to zero from the high usage during intervention periods.
It is Waterloo, Not Dunkirk
This brings us back to the metaphor at the beginning. The core logic of the Dunkirk evacuation is that the besieged Allied forces withdrew their soldiers back to their homeland after failure, preserving their living force to ultimately return to the battlefield. Comparing the yen carry trade to Dunkirk has its strategic rationale; FIMA has indeed provided carry traders with the time and space for orderly unwinding, avoiding the devastating consequences of a disorderly踩踏.
But it has a crucial misalignment. The Dunkirk evacuation involved "our own people," whereas FIMA covers "market counterparts." The soldiers of Dunkirk returned to the battlefield, while yen carry traders are unlikely to return. The conclusion of the carry trade is not a tactical retreat but a strategic demise. The game rule of borrowing yen to buy dollar assets, which has lasted for thirty years, is being permanently rewritten.
Rather than Dunkirk, it is more akin to Waterloo. A graceful defeat, the closing chapter of an era. As one analyst said, the unwinding of yen carry trades is more like an amplifier of the market's decline, rather than the sole cause of triggering a crisis. What truly needs to be heeded is the resonance between concentrated yen shorts, shifts in central bank policies, and corrections in global tech stock valuations. FIMA has merely bought time but cannot alter the inevitable retreat of the carry trade.
Asset Allocation Logic Under the New Paradigm
For investors, this judgment signals profound implications for asset allocation. The model of boosting U.S. stocks and Treasuries through cheap yen over the past thirty years is becoming untenable. Under this new paradigm, the logic of asset pricing is undergoing a fundamental reconstruction.
Assets that are not constrained by any single sovereign credit, represented by Bitcoin and gold, will experience true value reassessment during the cycle of renewed flooding of dollar liquidity. FIMA has only made this ending appear more dignified, but the conclusion is already determined. Money printing is a political decision made to address unsustainable economic realities; when the money-printing machine is started again, the one standing at the source of liquidity will stand at the starting point of the next cycle.
U.S. tech stocks will still face deleveraging pressure in the short term, but in the long term, the redefinition of which companies are truly worth holding will come from the digestion of valuations and verification of earnings. U.S. Treasuries have avoided the worst-case scenario with the support of FIMA, but the ongoing withdrawal of carry funds suggests that yield levels may remain elevated relative to pre-crisis benchmarks. Emerging markets, as passive recipients of less liquid assets, will bear the brunt of pressure during liquidation shocks, but economies with solid fundamentals may become value havens after the tide recedes.
The end of the yen carry trade is not the end of the world; it merely signifies the turning of a chapter in global capital flows. Who will write the next chapter depends on the Fed's balance sheet, the path of rate hikes by the Bank of Japan, and global investors' choices in reallocating assets under the new paradigm. In this process, maintaining a clear mind and flexible strategies is more crucial than any linear extrapolations based on historical experiences.
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