The yen plummeted, triggering a new round of crisis? Oil prices soaring may dismantle arbitrage trading, posing a risk of "water withdrawal" for $1.2 trillion in U.S. bonds.

Martin Peletier, portfolio manager at TriVest Wealth Counsel, said that the continuously rising oil prices may put pressure on the yen and threaten the popular "yen carry trade", potentially affecting liquidity in the US bond market and causing new pressures in the global financial markets. Due to the ongoing conflicts in the Middle East, the yen exchange rate has plummeted sharply to its lowest level since 2024. On Friday, the yen against the US dollar fell by 0.2% to a low of 159.69. Peletier pointed out that Japan is particularly vulnerable to energy shocks because the country relies heavily on imports for almost all its fuels. He wrote, "Rising oil prices pose a significant risk to Japan, as the country relies heavily on imports for almost all its energy." He added that the rising cost of crude oil would quickly expand the country's trade deficit and weigh on the exchange rate. This dynamic could evolve into a self-reinforcing cycle. Peletier stated, "High oil prices will immediately expand Japan's trade deficit, putting downward pressure on the yen." As oil is priced in dollars, a depreciation of the yen would increase local energy costs, transmitting import inflation through electricity, transportation, and broader consumer prices. This pressure could force the Bank of Japan to adjust its policies, potentially undermining the economic basis of the widely used yen carry trade, as this trade relies on Japan's extremely low interest rate levels. Peletier also emphasized the impact on the US bond market. He said, "Japan holds around $1.18 trillion to $1.20 trillion in US Treasury bonds, making it the largest foreign holder," and pointed out that Tokyo had sold US Treasury bonds to provide funds for foreign exchange intervention during the oil price spike after the Russia-Ukraine conflict in 2022.