The Yen's Collapse: A New Era for Carry Trades and EM Exposure

The Japanese yen's dramatic swings in 2023–2025 have reshaped global capital flows, triggering a seismic shift in carry trade dynamics and emerging market (EM) exposure. As the Bank of Japan (BOJ) reversed its decades-long ultra-loose monetary policy, the yen's trajectory-from a 157.2 per USD in 2024 to 148.56 by September 2025-has forced investors to recalibrate portfolios toward high-yield currencies and EM assets. This article examines how the yen's collapse (and subsequent rebound) has disrupted traditional carry trade strategies and why rebalancing toward EM currencies is now a critical priority for investors.

The Yen's Volatility and the Carry Trade Unwind

The yen's performance has been a double-edged sword. In 2024, the BOJ's rate hikes and tapering of quantitative easing pushed the yen to a 15-year high against the dollar, ending a 15-year period of near-zero rates, according to a FocusEconomics forecast. This forced a rapid unwinding of the yen carry trade-a strategy where investors borrowed low-yielding yen to fund higher-yielding assets in the U.S. and EM markets. A Wellington report found that this unwind triggered a sell-off in U.S. momentum stocks and a reevaluation of global investment strategies. By 2025, however, the yen weakened again, with forecasts predicting a rate of 149.49 by year-end, per Trading Economics. This volatility underscores the fragility of carry trade positions in a world of divergent monetary policies.

Emerging Markets: Winners and Losers

The yen's fluctuations have had mixed effects on EM currencies. Countries like Brazil and Mexico, with high-yielding assets and proactive central banks, have attracted capital inflows, according to a Fortune article. For instance, the Brazilian real and Mexican peso have gained traction as investors seek alternatives to the U.S. dollar. Meanwhile, Asian markets such as South Korea and Hong Kong have faced downward pressure due to reduced demand for their equities as Japanese investors repatriate funds, an IBAFin analysis argues.

The unwinding of the yen carry trade has also exposed vulnerabilities in EM economies. A BIS report notes that firms with significant U.S. dollar-denominated liabilities face heightened balance sheet risks during periods of yen strength and dollar depreciation. However, EMs with solid fiscal fundamentals-such as India, Poland, and the Czech Republic-are emerging as resilient targets for high-yield investments, Wellington also notes.

Portfolio Rebalancing: Strategies for a New Era

To navigate this shifting landscape, investors must adopt systematic rebalancing strategies. Forbes recommends allocating 2–8% of portfolios to EM currencies or ETFs, depending on risk tolerance. Key tools include:

1. ETFs for Diversified Exposure:
2. Cambria Global Asset Allocation ETF (GAA): Offers a 45/45/10 split across stocks, bonds, and commodities, with a 10% allocation to EM currencies, per Morningstar.
3. iShares MSCI Emerging Markets ETF (EEM): Provides broad equity exposure to EM markets, including Brazil, India, and South Africa, according to U.S. News.

4. Vanguard Emerging Markets Bond Fund (VEMBX): Focuses on sovereign debt from high-yield EMs like Mexico and Turkey, as U.S. News notes.

5. Tolerance Bands for Rebalancing:
   T. Rowe Price advocates using 2% or 20% relative bands to trigger rebalancing, ensuring portfolios stay aligned with long-term goals. For example, if EM exposure drifts above 8%, investors might reduce holdings in favor of high-quality bonds or commodities.

6. Dynamic Equity/Fixed-Income Allocations:
   Vicapartners suggests shifting to 50/50 or 70/30 equity/fixed-income splits based on macroeconomic conditions. In 2025, with EM equities outperforming U.S. counterparts by over 11 percentage points, a 60/40 split favoring EM equities and inflation-protected bonds is prudent, according to an HSBC analysis.

The Road Ahead

The yen's collapse and subsequent rebound highlight the need for agility in portfolio management. While the unwinding of the carry trade has introduced volatility, it has also created opportunities for EM currencies with strong fundamentals. Investors who rebalance toward high-yield EM assets-using ETFs, tolerance bands, and dynamic allocations-can capitalize on this new era while mitigating risks. As the BOJ continues to navigate inflation and growth, the interplay between yen policy and global capital flows will remain a defining theme for 2025 and beyond.