A 10 year yield around 2.1% doesn’t sound dramatic if you’re used to U.S. or Australian bonds. In Japan, it’s a regime shift.

For nearly three decades, Japan’s bond market lived off the assumption that rates stay low forever. After the bubble burst, everything reinforced that belief…weak growth, falling prices, aging demographics, and a central bank willing to suppress yields at almost any cost. That’s why betting against JGBs became known as the “widowmaker trade.” People tried to call the turn for years and got crushed.

So when the 10 year moves back toward levels last seen in the late 1990s, the signal isn’t that Japan is finally normal but rather that one of the anchors holding global rates down is starting to lift.

Japan has long been a major exporter of capital because money was so cheap at home. Ultra low yields pushed Japanese institutions and global funds borrowing yen outward in search of return. As domestic yields rise, that outward flow weakens, and global funding dynamics begin to shift.

Japan’s Delayed Inflation Experiment

What makes this moment more interesting is why yields are rising.

Japan is running a version of the inflation experiment the U.S. ran after Covid, just later, and through a different channel. After Covid, Japan slid back toward deflation as weak demand, demographics, and a less supportive global growth model reasserted themselves.

Instead of mailing checks, Japan applied political pressure to force broad corporate wage hikes. Different mechanism, same goal of getting money into the real economy and break the deflation mindset.

Wages matter because they’re what make inflation stick. You can subsidize prices or stimulate temporarily, but without rising incomes, inflation fades. Japan is trying to pry open a wage channel it couldn’t sustain for decades.

The uncomfortable reality is that if that wage and demand push isn’t continually reinforced, inflation doesn’t just cool, it collapses, drifting back toward the deeper deflation Japan knows too well. In that sense, today’s inflation isn’t the core problem. It’s the cover, a thin layer of price pressure sitting on top of a much larger deflationary structure shaped by debt, demographics, and slower global growth.

That’s why Japan is walking such a narrow line…normalize too fast and deflation returns; stimulate too little and the wage experiment fails.

Why This Matters For The Yen Carry Trade

The yen carry trade works only when funding is cheap, the yen is stable or weakening, and volatility stays low. Break any of those, and the trade starts to wobble.

A Global Downturn Usually Breaks All Three At Once

In risk off moments, leverage comes down fast. Investors sell carry assets and buy back the funding currency. Short yen positions get covered, and the yen can jump sharply. This isn’t theory because it has happened repeatedly.

Volatility is the silent killer. Carry looks great when FX volatility is low. When volatility spikes, that steady pickup turns into forced exits at the worst time. The trade is effectively short volatility.

Rate differentials can also compress quickly. In a downturn, the Fed and others usually cut. If Japan is tightening or even just not easing, the gap narrows. Suddenly the yen isn’t free funding anymore.

My View

If the world rolls into a real downturn while Japan is still normalizing, the yen carry trade becomes a global deleveraging amplifier. It doesn’t cause the downturn, but it can make it sharper by forcing unwinds across FX, rates, and risk assets.

For years, Japan was the world’s cheapest, most reliable funding source.
If that era is ending, markets don’t just reprice Japan, they reprice the assumptions built on Japan staying pinned to zero forever.