Yen Surges but Fails to Trigger Market Panic Amid Carry Trade Debate

The latest market movements have added a new variable to the discussion on yen carry trade. On Monday this week, the yen surged against the U.S. dollar to its highest level in two months, sparking speculation that Japanese authorities might directly intervene in the foreign exchange market to support the yen. In the first hour of Tokyo's stock market opening, the yen rose approximately 1.1% against the dollar, breaking through the 154-yen level. Previously, the U.S. authorities' "interest rate inquiry" with market participants was seen as a possible precursor to market intervention. Japan's last direct intervention in the foreign exchange market occurred in 2024, when it purchased nearly $100 billion in yen over four interventions throughout the year to support the currency, at a time when the yen had fallen to around 160 yen per dollar.

This market fluctuation has once again brought into focus the high-frequency term in previous global macroeconomic narratives—"the reversal of yen carry trade."

The Maitong MSX Institute believes that the current market environment is characterized by a narrative structure in which the Bank of Japan gradually exits its ultra-loose monetary policy, leading to rising long-term interest rates; the Federal Reserve enters a phase of expected rate cuts, causing the U.S.-Japan interest rate differential to narrow. Theoretically, the interest rate foundation supporting global carry trades is being undermined. Within this narrative framework, a logical conclusion is that carry trade funds financing in Japanese yen and investing in U.S. dollar assets will be forced to unwind or repatriate. A capital outflow from Japan could negatively impact global risk assets, particularly the U.S. stock market.

But the problem is that the market has not followed this narrative. Even though the yen surged sharply on Monday, the yen has not experienced a sustained, one-sided significant appreciation over the past week or even longer. Although U.S. stocks have experienced some volatility, there has been no systemic selling, and global risk assets have not shown the typical characteristics of a "flight to liquidity" or "liquidity retreat." As a result, a seemingly sharp yet extremely critical question arises: if carry trades are indeed "reversing," why is there almost no trace of this in price movements, capital flows, or market structure?

To understand this situation, we must first dispel a common misconception: the "deterioration of arbitrage logic" is not equivalent to "large-scale withdrawal of arbitrage capital." Strictly speaking, what is currently happening is only the first stage of change: the interest rate differential is no longer widening, exchange rate volatility is increasing, and policy uncertainty is rising. These three factors indeed reduce the cost-benefit ratio of arbitrage transactions, but they have not yet triggered forced liquidation conditions. For large institutions, the decision to exit arbitrage positions is not based on whether the environment has worsened, but rather on whether the arbitrage has turned into a negative return, whether risks have increased in a non-linear fashion, and whether there are non-hedgeable tail risks. At the current stage, none of these three conditions have been fully triggered. As a result, arbitrage transactions have entered a "gray zone" where they are no longer comfortable, but still sustainable.

After in-depth research, the Maitong MSX Institute believes that arbitrage capital "should have flowed back" but has not returned in large volumes. The core reasons for this are threefold. Hard data can more clearly reveal the underlying truth— the truth is not hidden, but rather, the mathematical calculations still make it worthwhile.

First, the interest rate differential remains, but its marginal appeal has decreased, and the "margin of safety" is still substantial.

Whether the carry trade collapses hinges on whether it is still profitable to borrow yen to purchase U.S. dollar assets. Data shows that the interest rate differential provides sufficient cushion to absorb current exchange rate fluctuations. As of January 22, 2026, the actual U.S. federal funds rate was 3.64%, while the Bank of Japan's policy rate remained at 0.75% (raised to this level in December 2025, with no changes at the January 2026 meeting). The nominal interest rate differential between the two stands at 2.89% (289 basis points). This means that the carry trade will only incur losses if the yen appreciates by more than 2.9% annually.

Although the Japanese yen surged briefly by 1.1% on Monday, as long as this appreciation does not form a long-term trend, it is merely a "profit drawdown" rather than a "principal loss" for traders earning nearly 3% annualized returns. This is the core reason why there has been no large-scale unwinding of positions. At the same time, the actual interest rate differential further strengthens the incentive for carry trades: Japan's CPI remains at 2.5%-3.0%, resulting in an actual interest rate of -1.75% to -2.25% after adjusting for inflation, which effectively means borrowers are paying lenders to hold their money. In contrast, the U.S. actual interest rate is about 1% (3.64% interest rate minus 2.71% inflation). This nearly 3% actual interest rate differential provides much stronger support for carry trades than verbal interventions.

Second, modern arbitrage trading has long become "invisible," which is the most overlooked yet critical structural change in the market.

In the imagination of many people, the Japanese yen carry trade remains a simple chain of "borrowing yen → converting to U.S. dollars → buying U.S. equities → waiting for the interest rate differential and asset appreciation." However, in reality, a large volume of transactions is conducted through foreign exchange swaps and cross-currency basis swaps. Exchange rate risks are systematically hedged using forwards and options, and carry trade positions are embedded within multi-asset portfolios rather than existing in isolation.

This means that arbitrage funds do not necessarily need to take explicit actions such as "selling U.S. stocks and repurchasing yen" to reduce risk. Instead, they can adjust their positions by ceasing to roll over existing positions, reducing leverage ratios, extending holding periods, or allowing positions to naturally expire. As a result, capital outflows manifest in more subtle ways, such as a decrease in new capital inflows and existing capital remaining temporarily inactive.

Thirdly, a genuine "forced liquidation" requires extreme conditions, and currently, speculative positions have by no means "surrendered."

Looking back historically, a "stampede" in yen carry trade unwinding typically requires a triple shock: a rapid and significant appreciation of the yen, a synchronized decline in global risk assets, and an abrupt tightening of liquidity in the financing end. The current market does not possess such "resonance conditions." According to data from the CFTC (U.S. Commodity Futures Trading Commission), as of January 23, 2026, the non-commercial (speculative) net position in yen stood at -44,800 contracts. While this is a reduction from the peak in 2024 (over -100,000 contracts), it still reflects a net short position. This indicates that speculative funds are still shorting the yen and have not turned into net buyers. As long as this data remains negative, the so-called "massive withdrawal" is a fallacy.

In addition, the survivorship bias following the "crash" in April 2025 has reduced the current market's sensitivity to volatility. In April 2025, the VIX index surged to 60, and the tariff war had already eliminated all vulnerable leveraged capital with leverage exceeding 5 times. However, as of January 2026, the current VIX index is only 16.08, indicating a level of panic just one-fourth of that at the time. Today's market participants are all survivors who endured the VIX 60 crisis, so a mere 1.1% exchange rate fluctuation is not even significant enough for them to require margin adjustments.

However, the Maitong MSX Institute would also like to remind readers that, if we set aside "margin calls" and instead focus on changes in market structure, the impact of arbitrage trading has already become evident, though in a more subtle manner.

First, U.S. stocks have become more sensitive to interest rates and policy signals. In recent periods, the same magnitude of fluctuations in U.S. Treasury yields has had a significantly greater impact on growth stocks and technology stocks. This often indicates that the risk tolerance of marginal capital is declining. Once arbitrage capital stops providing "stable passive inflows," the market's pricing of macroeconomic variables becomes more fragile.

Second, the rise in U.S. stocks is becoming increasingly reliant on "internal capital," with corporate buybacks playing a stronger role in supporting the index, while the marginal contribution from overseas capital is declining. Although sector rotation is accelerating, the sustainability of trends is weakening. This is not a typical case of "capital withdrawal," but rather a sign that external liquidity is no longer expanding, and the market can only be sustained by its own internal forces.

Finally, volatility is suppressed but highly sensitive to shocks. During the phase where arbitrage capital becomes "defensive," the market often appears calm on the surface but is actually fragile. Normally, volatility remains low, but once policy changes or data shocks occur, the market's response is quickly amplified. This is precisely the typical characteristic of a high-leverage system during the risk-reduction process when leverage has not yet been fully unwound.

The Maitong MSX Institute believes that the day arbitrage trading truly collapses will not be repeatedly discussed in advance by the market. When during the trading session one simultaneously observes a sharp rise in the yen, a synchronized drop in U.S. equities, a rapid widening of credit spreads, and an out-of-control surge in volatility, it will already be in the stage of outcome. Currently, however, the market remains in a more delicate position—where the arbitrage logic has already been shaken, but the system is still delaying a breakdown.

This is precisely the most counterintuitive aspect of the current global market: the real risks do not come from changes that have already occurred, but from those "changes that have yet to happen but are steadily accumulating." If the Japanese yen carry trade used to be the invisible engine driving global risk assets, today it is more like a machine gradually slowing down but not yet fully shut off, and the U.S. stock market is currently riding on this decelerating conveyor belt.

Data does not lie. As long as the U.S.-Japan interest rate differential remains at 289 basis points and speculative positions still hold 44,000 net yen short contracts, U.S. stocks will not crash due to yen fluctuations. The current market stability is essentially due to the fact that mathematically, the critical point requiring an exodus has not yet been reached, rather than deliberate macro-level support.