The global financial crisis resulted in yen's replacement by dollar as the currency of choice for carry trade. However, with the onset of the US recovery as well as with little chance of Japan raising its interest rate, it is likely that yen carry trade will come into vogue again.

Currency carry trade is defined as a position in which a trader borrows money in one currency at a low interest rate and lends the same money in another currency at a higher interest rate. An investor trading carry trade derives profit from the difference in interest rates. The underlying expectation is that the currency in which the investment has been made would be stable. So, the difference in yields as well as expectations of stable currency values drives the investor. Over the past 10 to 15 years, Japanese interest rates have been below 1%, so investors borrowed in yen and invested in currencies with higher interest rates. Due to sluggish economic growth, the Bank of Japan resorted to the so-called zero interest rate policy from 1999 to 2006—Japanese short-term interest rate was merely 0.001% during this period. In comparison to Japanese yen, US dollar fetched higher interest rates particularly during the period 2000 to 2007—the interest rate was as high as 6%. This huge interest differential led to thriving yen carry trade. The currencies of the US and UK as well as the Euro Zone, Australia, New Zealand and even South Africa have also been the destination of choice for the investors borrowing in Japanese yen, given the high interest rates in the receiving economies.

However, in 2007, the global economy including the US, was caught in the worst financial crisis since the Great Depression of the 1930s. The Federal Bank of US had to lower the interest rates to approximately 0.1% to combat the crisis. Moreover, the severe crisis of confidence in the aftermath of recession pulled the US dollar down. The borrowing cost of dollar in the US nearly declined to the cost of borrowing in yen, and this eventually replaced yen as the currency of choice for carry trade and consequently dollar-funded carry trade burgeoned. Now, as the Japanese economy is again reeling under acute debt crisis and deflation, there is hardly any chance of tightening monetary policy i.e., raising interest rates. Moreover, expectations are high that with the onset of the recovery in the US, there may be a rise in interest rates, which is likely to do no good for the prospects of dollar carry trade. All these augur well for re-establishment of yen carry trade.

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