The decades-old link between the US-Japan interest rate gap and the yen exchange rate has snapped. Apollo Global Management says the yen carry trade broke down after April 2, 2025 — Liberation Day, when US tariffs were announced. Now, the yen is trading on Japan's fiscal outlook instead.
The breakdown of the yen carry trade
For years, traders borrowed cheap yen to buy higher-yielding assets elsewhere. That strategy relied on a stable relationship: when the US-Japan rate gap widened, the yen weakened. When it narrowed, the yen strengthened. That pattern held for decades — until April 2025.
Torsten Slok, Apollo's chief economist, put it bluntly: “The yen carry trade has broken down… the yen will trade on Japan's fiscal outlook rather than the interest rate gap.”
The numbers back him up. On August 6, 2025, the US 10-year Treasury yield was 4.64%, while Japan's 10-year bond yield was 2.76%. That's a gap of about 1.8 percentage points. Historically, that would have kept the yen weak. Instead, the yen hit 164 per dollar in late July — its weakest in four decades — then bounced back to near 157.9. The old rules no longer apply.
Japan's record budget and debt
Japan's fiscal 2026 budget hit a record ¥122.31 trillion ($774.5 billion). Debt servicing costs alone are ¥31.28 trillion ($198.08 billion) — also a record. The government now assumes a long-term interest rate of 3.0% for its budget, up from 2.0% a year earlier.
Japan's central government debt stood at ¥1,343.8 trillion ($8.51 trillion) as of March 31, 2025. Prime Minister Sanae Takaichi defends the debt-financed spending plan. She aims for a primary balance surplus — the first since 1998 — and relies on ¥29.58 trillion ($187.3 billion) in fresh borrowing.
That debt load is what investors are now watching. With the carry trade broken, the yen's fate is tied to whether Japan can manage its finances. Higher bond yields mean higher debt costs, which could force more borrowing — a cycle that spooks currency markets.
Intervention and the Bank of Japan's next move
Japan intervened to buy yen on July 30, 2025. The United States joined the next day, July 31. The last US yen purchase was on June 17, 1998 — just $833 million. A leaked note from Treasury Secretary Bessent estimated the US intervention at $5-10 billion.
Japan's finance ministry had disclosed zero intervention through July 29. The July 30 operation will be reported in the next monthly report due late August.
Vincent Chung of T. Rowe Price said intervention may slow yen depreciation rather than lead to a lasting reversal. That's a cautious take — and it matches the data. The yen recovered some ground, but the underlying fiscal pressure hasn't gone away.
The Bank of Japan raised its policy rate to around 1% on July 31, 2025, by an 8-1 vote. Board member Hajime Takata dissented, favoring 1.25%. The BOJ's next policy meeting is scheduled for September 17-18, 2025. That's when markets will see if the central bank is willing to raise rates again — and whether that can stabilize the yen without crushing Japan's debt-laden economy.
