Since the start of 2026, the yen has collapsed to its lowest level in nearly forty years against the dollar, crossing the threshold of 160 to 162 yen per dollar in July. This depreciation has been accompanied by a simultaneous surge in Japanese bond yields: the 40-year rate exceeded 4% for the first time since this maturity was created in 2007, while the 10-, 20-, and 30-year rates all hit records not seen since 1999.
This dual slide — currency and debt falling together — breaks with the classic logic of foreign exchange markets, where a rise in interest rates is supposed to support the national currency. Since June 2025, the correlation between the Japan-US interest rate differential and the yen’s exchange rate has even reversed: a narrowing of the rate gap is now accompanied by a depreciation of the yen rather than an appreciation. This signal indicates that markets are no longer reacting to the usual interest-rate mechanisms, but are pricing in directly a risk of crisis in Japanese sovereign debt, whose level — between 232% and 266% of GDP depending on the measure used — remains the highest of any major developed economy, roughly twice that of the United States.
Faced with this slide, Japan and the United States carried out a rare joint intervention in the foreign exchange market in late July and early August — the first cooperation of this kind since 1998 — in an attempt to stabilize the yen. The Bank of Japan had already spent around 77 billion dollars between late April and late May to defend its currency, without preventing the yen from crossing the 160 threshold. The lasting effectiveness of these interventions remains highly debated.
The Culprit: The Carry Trade Mechanism
This crisis is explained above all by the carry trade mechanism — a speculative operation made possible by decades of near-zero interest rates in Japan. The principle is simple: investors borrow in yen at very low rates, convert the sum into dollars to invest it in higher-yielding assets (US Treasury bonds, corporate bonds, equities), and thereby pocket the interest rate differential — currently estimated at between 275 and 300 basis points between the two countries. A concrete example illustrates the mechanism: an investor borrows 100 million yen at a rate close to 0-1%, converts it into dollars to place it in an asset yielding around 4%, pocketing the yield spread (the “carry”) for as long as they keep servicing their yen loan; if the yen depreciates in the meantime, they benefit from an additional currency gain when converting their dollars back to repay the debt — but conversely, a sudden appreciation of the yen can wipe out the entire accumulated interest gain in one stroke, which explains the brutality with which such positions tend to unwind.
This mechanism has turned into a self-reinforcing vicious circle: the more the yen depreciates, the more of an incentive speculative funds have to short the yen (an operation that consists of borrowing an asset — here, yen — to sell it immediately, in the hope of buying it back later at a lower price and pocketing the difference), which further intensifies its depreciation. Notably, it is ultimately Japan’s own financial players — life insurance companies, pension funds, individual savers who parked their capital abroad during decades of zero interest rates — who have largely fueled the short-selling of their own currency, before beginning a capital repatriation movement now that domestic bond yields (30-year rates approaching 4%) make national savings attractive again.
This reversal has one well-documented concrete consequence: Japan, which still held around 1,240 billion dollars in US Treasury bonds in February 2026, has already sold off nearly 100 billion in just over three months — with Japanese private investors alone offloading around 29.6 billion dollars of US debt in the first quarter. Japan’s “autopilot buyer,” which supported global bond markets for decades through the export of cheap capital, thus appears to be going into reverse.
Structurally, Japan’s public debt stands at 1,343 trillion yen, interest payments on this debt already account for around 25% of the state budget, and every percentage-point rise in rates adds several trillion yen in additional annual costs — which explains why Tokyo dreads, above all else, having to significantly raise its policy rates: such a decision would amount to cutting off the Japanese economy’s oxygen supply. The most pessimistic scenarios envisage a continued slide of the yen toward 170, or even 180 to the dollar, a possible collapse of the Nikkei index — currently propped up artificially by the currency’s weakness — a wave of small-business bankruptcies, and continued erosion of household purchasing power, with real wages in Japan already having declined for 25 consecutive months and the Engel coefficient (the share of household budgets spent on food) at its highest level since 1981.
A Systemic Risk
Beyond its purely Japanese dimension, this crisis raises a broader systemic risk for the entire global financial system.
The gradual normalization of Japanese monetary policy — which began with the exit from negative rates in March 2024, the first rate hike in seventeen years, and continued through the June 2026 rate rise — has put an end to decades during which Japan fueled two major global financial flows: on one hand, the speculative carry trade described above; on the other, a structural financing, through Japanese capital, of US debt and emerging markets (Mexican and Brazilian sovereign bonds, technology stocks, cryptocurrencies). The simultaneous unwinding of these two flows lies at the heart of the systemic risk: this is no longer simply a Japanese currency crisis, but the gradual withdrawal of a buyer that has structured global bond markets for several decades.
Japan could thus be the first domino in a broader global sovereign debt crisis. A key point in this respect: the Bank of Japan already holds nearly 48% of all outstanding Japanese public debt, which means the Japanese bond market is no longer truly a free market — the central bank having become the buyer of last resort, as the state is unable to finance itself at sustainable rates with private investors. Japan’s Ministry of Finance itself projects that debt-servicing costs could reach 40.3 trillion yen by fiscal year 2029, or around 30% of total public spending.
The gradual collapse of this “Japanese debt pyramid” could, sooner or later, cause bubbles to burst in other major financial markets — the United States and Europe in particular — through the channel of a large-scale repatriation of Japanese assets held abroad. This hypothesis underscores the structural fragility of the Western financial architecture: massive indebtedness among developed economies, masked for years by ultra-accommodative monetary policies, whose forced normalization of interest rates could soon reveal its true cost.