Can ASEAN+3 Withstand a Yen Carry Trade Reversal?

The yen’s appreciation in August 2024 underscored the risks associated with unwinding currency carry trades. Policymakers must implement safeguards to address volatile capital flows as ASEAN+3 deepens its integration into global financial markets.

The Impact of Yen Appreciation on Carry Trades

In August 2024, the sharp appreciation of the Japanese yen triggered concerns among investors involved in currency carry trades, a strategy capitalizing on interest rate disparities. This approach, where investors use a low-interest currency like the yen to invest in higher-yield currencies, had been profitable due to Japan‘s ultra-low rates. However, as the US Federal Reserve raised rates aggressively from 2022 onwards, carry trades became more lucrative, drawing considerable investments into yen-funded strategies. The reversal of this dynamic in mid-2024, driven by US economic signals and changes in monetary policy, led to a rapid appreciation of the yen, forcing investors to exit their positions and intensifying market volatility.

ASEAN+3 Exposure to Carry Trade Volatility

While ASEAN+3 economies, encompassing Southeast Asia, China, Japan, and Korea, had limited direct involvement in yen-funded trades, they weren’t entirely shielded from global financial volatility. According to AMRO‘s analysis, ASEAN currencies were not primary targets for carry trades, as they demonstrated weak negative correlations with the yen. However, as global financial markets are deeply interconnected, speculative capital inflows could still pose risks such as asset bubbles and exchange rate fluctuations, thereby challenging local monetary policy and economic stability. Policymakers in these economies need to consider potential impacts even with limited direct exposure.

Policy Measures for Financial Stability

To mitigate these challenges, ASEAN+3 policymakers must take proactive measures to manage capital flows and enhance financial resilience. Introducing macroprudential regulations like countercyclical capital buffers can help stabilize credit growth and capital flows. Building robust financial markets by expanding domestic bond markets and encouraging local-currency financing can also reduce dependency on volatile foreign capital. Furthermore, increasing corporate and investor awareness, through financial education and foreign currency borrowing oversight, could prevent reckless speculation. By implementing these strategies, ASEAN+3 economies can better navigate the uncertainties of global capital flows and maintain economic stability.

Source: Can ASEAN+3 Weather a Yen Carry Trade Reversal?