Why U.S. Interest Rates Might Surge Long-Term Despite Near-Term Cuts: Unpacking the Yen Carry Trade Risks

This blog post challenges the consensus that U.S. interest rates will remain low, arguing that despite potential short-term Fed rate cuts, long-term rates could rise due to post-2020 money supply expansion, persistent inflation risks, and the unwinding of the massive yen carry trade. It explores how Japan's rising bond yields, estimated $1–20 trillion in carry trade exposures, and a looming $9.2 trillion U.S. Treasury maturity wall in 2025 could flood bond markets, spike yields, and disrupt equities. The post contrasts Fed Chair Powell’s cautious stance with Trump’s push for aggressive cuts, highlighting risks of a counterproductive policy move. A call for investor vigilance in navigating these global financial dynamics.

I wanted to share this concise analysis outlining a contrarian perspective on U.S. interest rates. While market consensus leans toward sustained rate reductions, the argument below suggests that even if the Federal Reserve implements cuts as a reactive measure (similar to the March 2020 drop from 1.5% to 1.0% and then 0% during COVID), longer-term pressures could drive rates higher. This view is grounded in monetary expansion, inflation dynamics, and the mechanics of the yen carry trade, with supporting data from reliable sources.

Core Question: Why Expect Interest Rates to Rise When Others Anticipate Declines?

The prevailing view assumes prolonged Fed easing to support growth and avert recession. However, short-term cuts could trigger unintended consequences, leading to a rebound in rates over the medium to long term. This is due to structural imbalances in global finance, particularly the unwinding of massive yen-denominated borrowing positions.

Historical Context and Inflation Drivers

Monetary Expansion: Approximately 80% of the U.S. M1 money supply has been created since 2020. M1 surged from about $4.8 trillion in April 2020 to $16.2 trillion by May 2020, and stands at around $18.8 trillion as of mid-2025. This unprecedented injection fueled demand-pull inflation.
Inflation Peak: Consumer Price Index (CPI) inflation hit 9.1% in 2022, prompting the Fed to hike rates aggressively to the current 5.25–5.5% range.
Rate Response: These hikes were necessary to curb inflation, but the underlying money supply overhang persists, setting the stage for potential reacceleration if liquidity floods back in.

The Yen Carry Trade: Mechanics and Risks

The yen carry trade involves borrowing at near-zero rates in Japan and investing in higher-yielding assets like U.S. Treasuries. Japan has maintained low rates for decades, enabling this strategy.

Recent Shifts: Japanese Government Bond (JGB) yields have risen sharply; the 30-year JGB yield, near zero in 2020, now hovers around 3%, while the 10-year is at 1.49% and 40-year at 3.29%. This narrows the yield differential, pressuring carry trades.
Unwind Trigger: A Fed rate cut could eliminate the incentive to hold these positions. Traders would exit by selling U.S. Treasuries and other dollar assets to repay yen loans, appreciating the yen against the USD and creating a "musical chairs" scramble. Late exits could amplify losses, unwinding the coiled spring of leveraged positions.
Scale of the Trade: Estimates vary widely due to its opaque nature, ranging from $350 billion (narrow currency-focused) to as high as $20 trillion (broader balance sheet exposures). More conservative figures from the Bank for International Settlements (BIS) suggest $1–1.7 trillion in yen-supplied FX derivatives. Globally, OTC derivatives total around $715 trillion, with over $500 trillion in interest rate derivatives.
Japan's Role: As the largest foreign holder of U.S. Treasuries (holding ~$1.13 trillion as of March 2025), Japan amplifies the risk—any mass selling could flood the market.

Policy Implications: Powell's Caution and Trump's Push

Powell's Stance: Fed Chair Jerome Powell has resisted immediate cuts, maintaining rates at 4.25–4.5% as of July 30, 2025, and stating no decisions have been made for September. This hesitation may stem from avoiding a carry trade unwind, which could destabilize markets. Powell has noted that premature cuts risk reigniting inflation.
Trump's Position: President Trump has aggressively advocated for rate reductions, suggesting cuts of up to 3 percentage points to lower debt servicing costs and boost growth. He could push for this by influencing Fed leadership changes.

Even if Trump succeeds in engineering short-term cuts, they may prove counterproductive:

Supply Tsunami: Carry trade unwinds could lead to a flood of U.S. bonds from Japanese sellers.
Maturity Wall: Compounding this, ~$9.2 trillion in U.S. Treasuries (about one-third of outstanding debt) matures in 2025, requiring refinancing amid potentially weak demand. This could push bond yields higher as secondary market demand weakens.
Market Shifts: Equity investors may flee to bonds for safety, creating a reverse "musical chairs" where bond supply overwhelms demand, further elevating yields.

Conclusion and Investment Considerations

In summary, while short-term Fed cuts might occur to stabilize markets, the interplay of excess money supply, yen carry trade risks, and the 2025 debt maturity wall could force long-term rates upward. This scenario warrants caution in duration-sensitive portfolios—consider hedging against yield spikes or diversifying into assets less tied to U.S. bond dynamics.

I'd value your thoughts on this perspective and any counterarguments from the team. Let me know if you'd like me to expand on specific data or scenarios.