WASHINGTON (Kyodo) The yen would probably stage a steep rally if financial market volatility were to trigger a rapid unwinding of yen carry trades, the International Monetary Fund said Tuesday.

“A volatility shock could lead to the rapid unwinding of carry trades,” the IMF said in its annual Global Financial Stability Report, referring to the deals in which investors borrow cheap funds in Japan to invest in higher-yielding assets elsewhere.

“To the extent that such unwinding involves a reduction in yen funding, a sharp yen appreciation would be possible, particularly in light of global imbalances,” the Washington-based lending institution said.

Yen-funded carry trades that involve hedge funds and other short-term investments have helped push down the yen against the dollar and euro.

The report says the risks involved in a possible unwinding of carry trades at this time would be less than in 1998. For a few days in autumn 1998, the yen soared by almost 15 percent against the dollar.

“The current situation seems less worrisome than the runup to the 1998 episode,” the IMF said, citing such reasons as the gradual narrowing of interest rate differentials among relevant countries and deeper financial markets better able to absorb asset price volatility.

According to the report, yen carry trades were worth approximately $170 billion, or some 20 trillion yen, in 2006 as calculated by the level of lending, derivatives and other investment outflows from Japanese banks.

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