BOK: "Only 300 Trillion Won in Liquid N Carry Funds, Volatility Must Be Noted"

Analysis shows that the balance of yen-based carry trade funds (yen carry funds) managed in the global market amounts to 506.6 trillion yen (4,704 trillion won), of which only the yen carry funds with high liquidation potential reach 32.7 trillion yen (300 trillion won). There are concerns that as yen carry fund liquidations increase, volatility in the international financial market may expand.

According to the report titled 'BOK Issue Note, Recent Changes in Yen Carry Trade Returns and Estimation of Liquidation Scale' released by the Bank of Korea on the 24th, yen carry fund liquidation is cited as a major factor in the expansion of volatility in the international financial market.

Carry trade refers to an investment strategy where funds are borrowed in a low-interest-rate currency, exchanged into a high-interest-rate currency, and then invested in that country to seek profits. While Japan has maintained a negative policy interest rate since 2016, the United States has kept relatively high interest rates in recent years, leading to the growth of the carry trade market between the yen and the dollar. However, this year, as Japan raised its benchmark interest rate and the U.S. lowered theirs, yen carry funds began to be liquidated.

The Bank of Korea defined yen carry funds broadly as three categories: non-commercial yen futures net short positions, yen loans by global banks, and overseas securities investments by residents of Japan. It explained that the total estimated size of these funds amounts to 4,704 trillion won.

The Bank of Korea estimated the scale of liquidatable yen carry funds as the extent to which these funds deviate from the long-term trend, calculating it to be about 300 trillion won, which is 6.5% of the total yen carry funds.

The Bank of Korea expects that if the U.S. Federal Reserve (Fed) continues to lower interest rates in the future, the incentive for yen carry trade will diminish, leading to partial liquidation of the accumulated yen carry funds. It warned that volatility in the global financial market could increase during the liquidation process, so caution is necessary for South Korea as well.

For yen futures trading, which is strongly speculative and has a short investment horizon, global shocks are immediately reflected in the foreign exchange derivatives market, so the liquidation speed is expected to be the fastest.

Yen loans by global banks are expected to be liquidated with some time lag because adjusting loan portfolios takes relatively longer than foreign exchange derivatives, and the investment horizon is also longer. During the two past economic crises in 2008 and 2020, yen carry funds exceeding the long-term trend were liquidated over about 4 to 5 quarters.

Overseas securities investments by residents of Japan are expected to be adjusted most gradually, given that investors such as pension funds and insurance companies, who invest with a long-term horizon, hold a large proportion.

A Bank of Korea official emphasized, "Although yen carry fund flows are not a main driver of the global financial cycle, they can act as a factor that amplifies volatility, so it is necessary to monitor yen carry fund flows more closely going forward."