As joint foreign exchange market interventions by the United States and Japan weaken expectations of a weak yen, a recommendation has emerged that close monitoring of the financial markets is necessary due to the rising risk of an unwinding of the yen carry trade.

The Korea Institute of Finance (KIF) made the remarks today (the 22nd) in a report titled "Inspection of Japan's Monetary Policy Stance and Yen Carry Trade Unwinding Risks."

The yen carry trade is a currency strategy of borrowing low-interest yen funds to invest in high-interest currency assets, and it is maintained based on the interest rate differential between the US and Japan, a weak yen, and low market volatility.

The report pointed out that as the Bank of Japan raised its policy rate to 1% in June, the highest level in 31 years, vigilance regarding fundamental changes in the low-interest borrowing environment is increasing.

It also noted that the US and Japan launched joint foreign exchange market interventions at the end of last month to defend the value of the yen, stating, "If expectations for a weak yen weaken, it could act as a factor increasing the risk of unwinding the yen carry trade."

According to the report, if the yen strengthens, upward pressure on the won-dollar exchange rate could be eased due to the synchronization between the Korean won and the Japanese yen.

However, if the strengthening of the yen and the narrowing of the US-Japan interest rate differential proceed rapidly, it could sharply trigger the unwinding of the yen carry trade and amplify volatility in global financial markets.

In fact, in August 2024, as weak US employment data coincided with the Bank of Japan's rate hike, yen carry trade positions were rapidly unwound, causing the KOSPI and KOSDAQ to plummet by 8.8% and 11.3%, respectively.

Nevertheless, the KIF assessed that the possibility of the interest rate gap between the US and Japan narrowing significantly in a short period is limited.

Since the Bank of Japan is also expected to pursue cautious rate hikes, it evaluated that the risk of a large-scale unwinding is not high.

The KIF advised, "In preparation for unexpected expansions in global financial market volatility, we must closely monitor the flows of yen carry funds and their direct and indirect impacts on the domestic financial market," adding that it is necessary to constantly monitor the possibility of major economies making monetary policy decisions that diverge from market expectations.