The logic of "cheap yen financing" is changing! Funds are reallocating "carry trades" as Swiss franc and Swedish krona compete for the funding currency position

According to Zhitong Finance APP, carry trade strategies revolving around the yen exchange rate appear to be undergoing a weakening of financing advantages and a restructuring of funding sources. The upward trajectory of the yen is eroding its attractiveness as a carry funding currency, prompting investors to consider alternative options such as the Swiss franc (CHF) and Swedish krona (SEK). If this major adjustment occurs alongside financial market deleveraging and large-scale sell-offs of high-liquidity risk assets like equities and bonds, it could result in significant selling pressure on related stocks, bonds, and high-yield currencies. Expectations of rate hikes by the Bank of Japan, combined with joint US-Japan interventions to buy the yen, have recently increased the overall exchange rate risk associated with borrowing low-interest yen to hold overseas assets.

A survey of economists released in September shows that respondents generally expect the Bank of Japan to raise the policy rate to 1.25% at the September 18 meeting, and to reach a decades-high benchmark of 1.75% by the second quarter of 2027. Compiled institutional statistics indicate that the classic carry strategy of selling yen and buying AUD generated about a 9% return in the first half of this year, but has lost approximately 1.3% since July. For investors, the attractiveness of such trades depends on both the interest rate on borrowed funds and the cost of repaying financing when the funding currency abruptly appreciates.

Carry trading typically involves borrowing in a low-yielding currency, exchanging it for another currency, and investing in higher-yielding assets to capture returns net of financing costs. Without adequate hedging, yen appreciation means a higher amount of foreign currency is needed to repay the same yen debt, with exchange losses potentially wiping out previously accumulated interest margins. When leverage is used, losses and margin calls can force investors to sell stocks, bonds, or high-yielding currencies, buy back yen to repay debts, and thereby amplify cross-market volatility. The Bank for International Settlements' research on the market turbulence in August 2024 points out that the unwinding of leveraged trades and higher margin requirements magnified the financial market's sell-off impact.

The Erosion of Yen Funding Advantage: Carry Trades Seek New Anchors Globally

Competition among alternative funding currencies has started, with CHF, SEK, and CAD each offering their own appeal and risks. It is understood that Wall Street asset managers and investing giants such as Russell Investments and Allianz favor CHF, while Wall Street commercial banking giant JP Morgan favors SEK and CAD as funding options, advising to sell the latter two and buy USD.

The Swiss National Bank kept the policy rate at 0% in June, diverging from Japan’s tightening direction; however, borrowing low-rate CHF exposes traders to its safe-haven appreciation risk, with European political turmoil or stronger global risk aversion potentially eroding carry returns. SEK and CAD are more sensitive to the economic cycle. As a result, funding choices must factor in not just interest differentials but also FX volatility, market liquidity, and positioning crowding. Yen demand may partially disperse, with no single currency fully replacing it.

As for the destination of funds after the yen carry trade unwinds, it first depends on whether investors switch funding sources or reduce overall leverage. If investors remain bullish on their original assets, they may borrow CHF or other currencies, exchange them to repay yen liabilities, and retain their foreign investments—reflecting a structural change in funding but not necessarily an exit from equities or bonds. If positions are closed, asset sale proceeds would first be used to buy yen and repay debt, with any remaining capital potentially reallocated to cash, short-term government bonds, or other investments.

In other words, the fading yen carry trade could manifest as a change in funding currency, a reduction in leverage, or both. Investors switching to CHF or similar funding may keep their existing overseas assets; those deleveraging could sell related assets and close out yen-funded positions. Therefore, carry trade adjustments do not correspond to a single direction of capital flow, and whether new investment allocations form depends on the residual funds post-closing and investor decisions.

Meanwhile, Japanese institutions will also re-evaluate returns on domestic versus foreign bonds after hedging FX risk, with some new allocation possibly remaining in Japan. The International Monetary Fund notes that rising Japanese bond yields could affect global asset allocations, though large institutional shifts are generally gradual. Thus, diversification in funding currencies, some degree of deleveraging, and increased domestic allocation in Japan may all happen concurrently.

For long-term capital still willing to take on equity risk, the sustainability of allocation to AI computing themes or AI-linked assets will increasingly hinge on whether commercial returns can cover capital costs and the high expenses of AI compute infrastructure.

From a technical perspective, AI inference and autonomous agent tasks require continuous model invocation, data retrieval, and result validation—creating opportunities for recurring service income but also continuous computing, storage, and network expenses. Mere consumption growth does not guarantee profit growth. If model and system optimization reduces rework, raises task success rates, and delivers cost savings or incremental revenue greater than deployment expenses, then stable demand for paid services is supported. Therefore, under tighter financing conditions, companies with robust cash flows, verifiable AI revenues, and reasonable returns on capital will be much better positioned to attract long-term capital. On September 15, some media reported that Japanese investors were net buyers of overseas equities by around 1.3 trillion yen in August, showing that foreign allocation and yen carry trade unwinding can coexist among Japanese funds.

The Yen Loses Its Edge as a Funding Currency, with Carry Traders Eyeing the Franc and Krona

With the yen’s recent surge making it less reliable as a funding currency, the Swedish krona and Swiss franc are becoming top candidates for carry trade funding currencies.

Russell Investments and Allianz favor the franc, citing widening policy divergence with Japan; JP Morgan strategists recommend the krona and the Canadian dollar, seeing them as attractive options.

All of these currencies are competing to replace the yen in carry trades, where investors borrow low-yield currencies to buy higher-yielding assets. For decades, the yen was the default currency to sell, but now, with Japanese bond yields rising and joint US-Japan interventions supporting the yen—highlighting a preference for higher Japanese rates and a stronger yen—the yen’s appeal is fading.

“Investors are still keen to participate in carry trades, but the interesting question is which funding currency to pick,” said Van Luu, Global Head of Fixed Income and Currency Solutions Strategy at Russell Investments.

He noted that Japan has intervened twice this year to support the yen and prepare markets for higher rates, essentially signaling a preference for a stronger yen. In contrast, Switzerland is expected to maintain zero rates through the end of 2027 and appears comfortable with a weaker franc to support its exporters.

Luu added, “If investors switch from yen to other currencies as their funding option, then from a valuation, monetary policy, and exchange rate policy perspective, the Swiss franc stands out as the most attractive choice.”

Performance data shows the allure of yen-funded carry trades is waning. Selling yen to buy high-yielding G10 currencies such as the Australian dollar would have resulted in a 1.3% loss since July, though there was a 9% gain in the first half of this year. By contrast, investors funding in Swiss francs could achieve a 14% total return by 2026.

As shown in the chart above, the focus of carry trades is shifting away from the yen—returns on franc-funded carry trades are rising while yen-funded trade returns are shrinking.

The yen has appreciated 3.3% this month, similar to the post-intervention rally in July, and the yield on Japanese two-year bonds has more than doubled since the beginning of the year. Meanwhile, the franc has come under selling pressure, down more than 1% against the dollar and 4.4% against the yen.

Neil Jones, Managing Director of FX Sales and Trading at TJM London, commented, “Selling francs to buy yen largely reflects a long-term shift in how funding currencies are used.”

However, this trade is not without risk. The yen remains far more liquid than most other currencies, and carry strategies work best in stable FX environments—yet the franc is one of the world's key safe-haven assets and often rallies significantly during times of geopolitical stress.

Greg Hirt, Chief Investment Officer for Multi-Asset at Allianz Investments, believes the franc can serve as a feasible “supplement” to the yen, but also points out that volatility is likely around the Italian and French elections next year.

He added, “Faced with European risks, the franc is clearly a safe-haven currency. If France faces real problems, the Swiss franc will surge significantly.”

Japan’s FX interventions have also disrupted another long-standing relationship critical to carry trade returns. For decades, the yen was the most sensitive currency to US interest rates—typically weakening as the US two-year Treasury yield rose. Now, other currencies have taken over that role.

Meera Chandan, Co-Head of Global FX Strategy at JP Morgan, says the Swedish krona and Canadian dollar are most vulnerable to higher global rates due to their low yields and cyclical sensitivity. She recommends selling these two currencies and buying the dollar, noting expectations that the Federal Reserve may hike rates twice this year, which is supporting the dollar.

Chandan remarked: “If you compare these with high-yielding developed market currencies such as the Australian and Norwegian krone, or with emerging market currencies offering even higher yields, there’s actually a considerable yield gap.” She added that the franc and New Zealand dollar also meet her selection criteria.