YCC, carry trades and the changing role of the yen

Interest rates have been rising in Japan while the yen has remained weak. This apparent anomaly signals a decoupling between exchange rates and yield differentials – a relationship that traditionally represents one of the main channels through which monetary policy affects foreign exchange markets.

In standard portfolio frameworks, higher domestic yields may, all other things being equal, coincide with short-term currency appreciation. But the relationship is not mechanical and depends on risk