Carry trade approaches "the eve before the final chapter": abnormal fluctuations in Japanese interest rates trigger global rebalancing

On December 4, 2025, Japan’s government bond market suddenly entered an abnormal state. The 30-year yield broke through its historical high of 3.445% in one move, the 20-year government bond returned to levels last seen at the end of the 20th century, and the 10-year yield, serving as the policy anchor, also rose to 1.905%, reaching this range for the first time since 2007.

Surprisingly, this loss of control over long-term rates was not triggered by a sudden change in macro data, but rather by a sudden acceleration in market pricing for a rate hike at the Bank of Japan’s upcoming meeting on December 18–19.

Currently, the implied probability of a rate hike in interest rate derivatives has climbed to over 80%, with market sentiment entering a “countdown mode” ahead of official policy statements.

The Invisible YCC Channel: The Yen Engine Behind Global Liquidity

To understand this round of turmoil, we need to revisit the Bank of Japan’s core policy framework of the past decade—Yield Curve Control (YCC). Since 2016, the BOJ has explicitly fixed the 10-year government bond yield in a tight range, maintaining near-zero financing costs through continuous bond purchases.

According to Maitong MSX Institute, this “anchored” rate policy has allowed global investors to borrow yen at almost zero cost for a long time, swap it for dollars via FX swaps, and invest in high-yield assets such as US stocks, tech stocks, US Treasuries, and even cryptocurrencies. The vast liquidity of the past decade did not come entirely from the Federal Reserve, but rather from this invisible funding channel provided by the BOJ to the world.

However, the essence of YCC is “artificial stability” that can only be maintained by the central bank’s continuous bond buying. Any ambiguity in the BOJ’s willingness, scale, or policy stance will tempt the market to preemptively test the strength of this “invisible rate anchor.”

In recent weeks, changes in the yen interest rate swap market have signaled a shift even earlier than government bonds: from 1-week to 1-year tenors, yen OIS rates have been steadily rising, with market expectations for the policy rate in a year jumping rapidly from 0.20% to around 0.65%, reflecting broad acceptance that “policy action is coming.” The large holdings of long-term assets by Japanese life insurers and major domestic institutions also add structural pressure to this policy shift—every 10 basis point rise in yields for bonds with maturities over 20 years means significant mark-to-market losses.

Policy Signals Move Forward, Communication Nuances Ignite Long-End Sell-Off

The market has therefore turned to focus on the nuances of BOJ communication. On December 1, Governor Kazuo Ueda, in a rare move during a routine speech in Nagoya, proactively referenced the next policy meeting and hinted at a shift away from mere observation with the phrase “decisions will be made as appropriate.” For a market that relies heavily on BOJ wording to judge policy paths, such language is enough to form a trigger point. Against the backdrop of thin year-end liquidity, even the slightest policy hint is amplified by the market, making long-term government bonds the first outlet for pressure release.

Complicating matters, today’s 700 billion yen 30-year government bond auction by the Ministry of Finance was seen as another “stress test” by the market. With declining overseas participation and heightened sensitivity to duration risk among domestic institutions, a surprise drop in bid-to-cover ratio could further intensify technical selling pressure on the long end. Unlike the relatively mild market reaction to the first YCC adjustment in December 2022, investors are now much more sensitive to policy exit, and the jump in long-term rates directly reflects this unease.

The Fragile Closed Loop of Carry Trades: This December Is Different

More concerning for global markets than the policy change itself is the potential for another chain reaction in carry trades. Borrowing yen, swapping for dollars, and investing in high-beta assets has been the largest cross-asset strategy of the past decade. If the BOJ widens the yield band, reduces bond purchases, or directly raises rates, yen funding costs will rise quickly. Carry positions will be forced to unwind early, requiring yen buybacks and causing a sudden yen appreciation. This, in turn, puts pressure on remaining yen shorts, triggering further forced stop-outs. The end result: liquidity is rapidly withdrawn and high-volatility assets fall in sync.

The events of August 2024 remain vivid. At that time, a seemingly dovish remark by Ueda was interpreted by the market as a turning point, the yen surged over 5% in a week, and tech stocks and cryptocurrencies plunged almost simultaneously. CFTC yen short positions were cut by 60% in just three days—the fastest leverage unwinding in a decade. This year, the negative correlation between the yen and risk assets has strengthened further: Nasdaq tech stocks, crypto markets, and Asian high-yield bonds have all shown exceptional sensitivity to yen volatility over the past year. While capital structure is changing, fragility is still on the rise.

Here, Maitong MSX Institute reminds readers that when the BOJ raised rates in January 2025, the policy move was a controlled “fine tuning”—it did not alter the market’s core view on interest rate differentials or trigger flashbacks to the August 2024 turmoil. This month, however, is entirely different: the market fears the BOJ may move from symbolic adjustments to a genuine rate hike cycle, which would reshape the funding structure of global carry trades. Increased duration exposure, more complex derivatives chains, and narrowing interest rate differentials are all happening simultaneously, making the market far more sensitive to the December policy path than at the start of the year.

It is also worth noting that the structural fragility of crypto assets has increased since the start of the year. The October 11 flash crash caused major market makers to sharply reduce their exposure, and both spot and perpetual markets are now at historically low depth levels. With market-making capability yet to recover, crypto markets are highly sensitive to cross-asset shocks, and if yen volatility triggers a global leveraged unwind, crypto assets may react in amplified fashion due to a lack of absorbing capacity.

A Wildcard from the Fed Meeting and Looking Ahead

Additionally, this year’s situation is compounded by a new uncertainty: the timing mismatch between the Fed’s and BOJ’s meetings. The Fed will meet first on December 11. If it delivers a hawkish message and dampens expectations for rate cuts in 2026, the interest rate differential may briefly support the dollar. Even if Japan hikes rates as expected, the yen might paradoxically weaken rather than rise. This would leave carry trade unwinds directionless and turn what could have been an “orderly deleveraging” into chaos. For this reason, the policy rhythm of the next two weeks is more worthy of vigilance than the surface volatility of the markets.

From a longer historical perspective, Japan’s policy inflection points are highly path-dependent. December 2022 was a turning point, August 2024 was a flashpoint, and December 2025 feels more like a dress rehearsal for the final act. Gold has quietly risen above $2,650/oz, and the VIX continues to climb in the absence of major events. The market is preparing for some kind of structural change, but is not yet fully psychologically ready.

Maitong MSX Institute believes that if the BOJ implements a 25 basis point rate hike at the December meeting, global markets may experience a three-stage reaction: (1) short-term, rapid yen appreciation, rising US Treasury yields, and spiking volatility; (2) medium-term, systematic withdrawal of carry capital from high-beta assets; (3) long-term, the impact depends on whether Japan establishes a clear rate hike path or if this is just a symbolic move. In this environment, the global liquidity structure supported by a “cheap yen” can no longer be sustained, and more importantly, investors need to reassess the hidden dependence of their portfolios on the yen funding chain.

Conclusion

The storm may be unavoidable, but whether chaos can be managed will be determined by two key dates: the Fed meeting on December 11 and the Japanese government bond auction on December 18.

Global markets stand at the threshold between old and new paradigms, and the violent swings in Japan’s long-term rates may be just the prologue.