Before April 2025, the USD/JPY currency pair showed a close correlation with the 10-year interest rate differential between U.S. and Japanese bonds, as illustrated in Figure 2.

This is because investors engaged in carry trades by borrowing yen to finance higher-yielding U.S. assets.

This relationship broke down after Trump’s “Liberation Day” tariffs, when the uncertainty surrounding the trade war triggered a sharp spike in market volatility, forcing investors to unwind part of their carry trade positions.

Meanwhile, the 10-year U.S. Treasury yield, currently about 2.0 percentage points above Japan’s 10-year yield, has declined by -1.0 percentage points since April 2025, approaching the lowest gap seen since 2021.

Despite the narrowing yield spread, the USD/JPY continues to rise, with the dollar strengthening against the yen.

In the past, when the yen weakened, investors borrowed yen to buy dollars and profited from the interest rate differential. The larger the U.S.-Japan interest rate gap, the more the yen depreciated. This logic worked smoothly for many years.

Now, it suggests that carry trades are losing their influence, and the yen is no longer primarily driven by interest rate differentials, as investors increasingly factor in Japan’s heavy debt burden and rising debt servicing costs into pricing.

Japan’s escalating debt costs are becoming impossible to ignore.

Markets no longer care much about interest rate spreads; instead, they are increasingly alarmed: Japan’s government debt exceeds 2.5 times its GDP—the highest globally—annual interest payments amount to 1.65 trillion yen, and bond yields continue to rise, meaning interest payments grow ever larger.

Previously, people asked: “How much profit can be made from carry trades?”

Now the central question is: “Can Japan actually repay its debts?”

The pricing logic for the yen has changed. The modest profits from interest rate differentials have been overshadowed by the dominant risk of sovereign credit.

Bessent left behind a note to buy yen—a deliberate act staged for Reuters photographers, hoping to encourage more buyers to follow, not relying solely on U.S. and Japanese players.

When the yen fell to 164, what the U.S. was truly concerned about was no longer unwinding carry trades, but rather the potential collapse of Japan’s fiscal stability, which could drag down U.S. Treasuries and force the U.S. to suffer alongside Japan.

Bessent isn’t saving Japan or the yen—he’s saving U.S. Treasuries.

The next question: Can this rescue even work?

Japan’s real dilemma: massive debt, fragile exchange rate, stock market bubble, nearly exhausted monetary policy tools, high-visibility fiscal expansion under Shigeru Ishiba, plus persistent speculators still betting on carry trades.

Bessent’s hints and the Bank of Japan’s open intervention are merely band-aids, while Japan’s underlying crisis demands radical surgery.

Japan is essentially America’s proxy. If Japan collapses, America will follow. Therefore, if one is bearish on the U.S., rescuing the yen would be akin to drinking poison to quench thirst.

From another angle, undermining Japan is tantamount to crippling America.

Original source: toutiao.com/article/1872654464547852/

Disclaimer: The views expressed in this article are solely those of the author.