[Edaily Marketin JI YEONG-EUI Reporter] The “yen carry trade”—in which investors borrow yen at low interest rates to invest in assets in countries with higher interest rates, such as the U.S.—is once again emerging as a source of instability in global financial markets. Analysts say that if the value of the yen rises rapidly due to interest rate hikes in Japan and currency market interventions by the U.S. and Japan, the domestic stock market could be impacted as investors sell overseas assets and buy yen to repay their debts.

However, since it is unlikely that the interest rate differential between the U.S. and Japan will narrow significantly in the short term, the likelihood of a large-scale liquidation event like the one in August 2024 recurring immediately is considered relatively low.

According to a report titled “Review of Japan’s Monetary Policy Stance and Yen Carry Trade Unwinding Risks,” published by the Korea Financial Research Institute on the 22nd, HSBC estimated that the global yen carry trade fund size exceeds $1 trillion.

The yen carry trade is a strategy in which investors borrow the low-interest-rate yen to invest in assets denominated in high-interest-rate currencies, thereby profiting from the interest rate differential. This strategy is more favorable when the interest rate differential between Japan and the target investment country is large and the yen remains weak. Another characteristic is that stable returns can only be achieved when market volatility is low.

Conversely, if Japanese interest rates rise or the yen strengthens, the dollar-denominated value of the borrowed yen increases, raising the burden of repayment. This can trigger a chain reaction of liquidations, in which investors sell their assets and buy yen to repay their debts, causing asset prices to fall and the yen to strengthen in a mutually reinforcing cycle.

Recently, net non-commercial yen futures short positions—one of the indicators reflecting the trend of the yen carry trade—have approached levels seen during the 2024 market shock. Net short positions in the yen have risen rapidly since May 2025, reaching 163,000 contracts as of the 28th of last month. This figure is approaching the 184,000 contracts recorded in July 2024.

The environment for yen carry trades has also changed. On June 16, the Bank of Japan raised its policy interest rate to 1% and hinted at the possibility of further tightening. This marks the first time the Bank of Japan’s policy rate has reached 1% in 31 years, since 1995.

Another factor is that the United States and Japan have joined forces to defend the value of the yen. On the 31st of last month, the U.S. Treasury Department carried out a coordinated intervention with the Japanese Ministry of Finance by selling euros and buying yen. This marks the first time in 28 years—since 1998—that the U.S. has intervened in the foreign exchange market to induce a stronger yen.

Immediately following the intervention, the yen-dollar exchange rate dropped by about 5 yen in just one hour, falling from 162.8 yen to 157.8 yen per dollar. U.S. Treasury Secretary Scott Bessent also stated that he would not hesitate to carry out further coordinated intervention to correct the yen’s weakness.

A strong yen is not necessarily a bad thing for the domestic financial market. Since the won and the yen tend to move in tandem, a rise in the yen’s value can cause the won to appreciate as well, potentially easing upward pressure on the won-dollar exchange rate. The problem arises when the yen strengthens too rapidly. If yen carry trade funds flee all at once, global asset prices could undergo a correction, and the domestic financial market could see increased outflows of foreign capital and greater exchange rate volatility.

In fact, in August 2024, a combination of a stronger-than-expected interest rate hike by the Bank of Japan and weak U.S. employment data led to a sharp liquidation of yen carry positions. On August 5 of that year, Japan’s TOPIX index fell 12%, and the yen-dollar exchange rate dropped 5.2% over five trading days, falling to 145 yen per dollar.

The domestic market was also unable to avoid the shock. On the same day, the KOSPI and KOSDAQ plunged by 8.8% and 11.3%, respectively, and circuit breakers were triggered simultaneously in both markets. The won-dollar exchange rate also fluctuated sharply during the session, ranging from 1,359.0 won to 1,375.1 won.

The Korea Institute of Finance assessed that, for now, the likelihood of a large-scale liquidation similar to that event is relatively low. This is because the Bank of Japan is expected to be cautious about further interest rate hikes, mindful of the 2024 shock, and because concerns over Japan’s fiscal soundness limit the possibility of a sharp, short-term appreciation of the yen.

The possibility of further interest rate hikes by the Federal Reserve (Fed)—driven by robust U.S. private consumption and inflationary pressures stemming from the U.S.-Iran conflict—also serves as a factor preventing a sharp narrowing of the U.S.-Japan interest rate differential. Investment in artificial intelligence (AI) and funding demands from major global tech companies, expected to continue through 2028, could also exert upward pressure on interest rates in major economies, including the United States.

The Korea Institute of Finance emphasized the need to prepare for the possibility that unexpected monetary policy moves or foreign exchange market interventions could trigger a unwinding of yen carry trades. The assessment is that authorities must closely monitor the movements of global yen carry funds, the resulting adjustments in domestic asset prices, and the inflows and outflows of foreign capital, while also continuously assessing the possibility of monetary policy decisions by major economies that deviate from market expectations.