Author and Editor-in-Chief: Vitaliy Kisterny 01.11.2026 20:15:00

By 2028, the Bank of Japan may raise its key interest rate to 2%, if inflation continues to accelerate. For the dollar, this will be a serious test: Japanese investors, who for years have been financing American assets through the carry trade, will start returning capital home.

This process has already begun, but a rate hike to 2% could accelerate it several times over. The dollar, which has grown accustomed to relying on Japanese capital, may face the largest outflow in decades.

Carry trade: the dollar's hidden support

The yen carry trade is one of the most powerful forces in the currency market. Investors borrow money in Japan at almost zero interest rates and invest it in higher-yielding assets, including American bonds and stocks. The volume of these operations is estimated to be in the hundreds of billions of dollars. They create a constant demand for the dollar, as it is necessary to convert yen into American currency to buy American assets.

In 2026, the Bank of Japan began raising interest rates, and the carry trade started to unwind. The yen strengthened to seven-month highs, and the dollar lost some of its support. If the interest rate reaches 2%, the difference in yields between the US and Japan will decrease to the point where the carry trade will become unprofitable. This will trigger a massive outflow of capital from American assets.

What will happen at a 2% interest rate

At a 2% interest rate, Japanese investors, who hold a significant portion of American bonds and stocks, will start selling these assets and returning capital home. This process has already begun, but a rate hike to 2% could accelerate it several times over.

The pressure on the dollar will come through two channels. Firstly, the sale of American assets will require converting the proceeds into yen, which will strengthen the Japanese currency and weaken the dollar. Secondly, the reduction in the carry trade will decrease the structural demand for the dollar, which has supported it for years.

The scale of the decline will depend on the speed of the interest rate hike. If the Bank of Japan acts gradually, the market will have time to adapt, and the weakening of the dollar will be moderate. If the interest rate is raised sharply, it could trigger panic and a mass exit from the carry trade, leading to a deeper decline in the dollar.

Who will benefit from the strengthening of the yen

The main beneficiary will be the Japanese yen, which will strengthen against the dollar and other currencies. European and Asian exporters will also gain an advantage, as their goods will become more competitive. Gold may benefit if investors start looking for defensive assets outside the dollar system.

However, this scenario has a downside. The strengthening of the yen will hit Japanese exporters, who are accustomed to a weak currency. The Bank of Japan may face political pressure to slow down the rate hikes. This creates a risk that the process will be uneven and unpredictable.

What this means for the dollar

The dollar in 2027-2028 may face the largest capital outflow in decades. Japanese investors, who have been supporting American assets for years, will start returning capital home. This will weaken the dollar, but not collapse it, as other factors - the Fed, the US economy, and structural demand - will continue to support the currency.

Nevertheless, this scenario shows how much the dollar depends on global capital flows. If Japan stops being a source of cheap money, the dollar will have to look for new support. And this may turn out to be more difficult than it seems.