Key facts
- Overseas investors can now find "reverse carry" trade opportunities due to rising Japanese bond yields, according to Eastspring Investments.
- The traditional yen-funded carry trade is becoming less compelling as the Bank of Japan raises interest rates.
- Buying ultra-long Japanese government bonds and hedging yen exposure could offer higher yields than comparable bonds in other developed markets.
- The 30-year Japanese government bond yield above 4% offers a 100 to 200 basis points higher FX-hedged yield compared to dollar equivalents.
- Markets expect Japan's policy rate to eventually reach around 2% from its current 1.25%.
Rising Japanese bond yields are creating a "reverse carry" trade opportunity for overseas investors, as the Bank of Japan's interest-rate hikes make the traditional yen-funded carry trade less compelling, according to Rong Ren Goh, a fixed income portfolio manager at Eastspring Investments. Japanese asset prices have seen sharp swings following recent rate hikes by both the US Federal Reserve and the BOJ. Goh suggested that buying ultra-long Japanese government bonds and hedging yen exposure back into currencies like the dollar could offer investors higher yields compared to similar bonds in their home markets. He noted that the 30-year Japanese government bond yield, currently above 4%, provides an FX-hedged yield 100 to 200 basis points higher than its dollar equivalent. The traditional yen-funded carry trade, which involves borrowing cheaply in yen to invest in higher-yielding foreign assets, is no longer considered a "no-brainer" as markets anticipate Japan's policy rate to eventually rise to around 2% from the current 1.25%. Goh anticipates the reverse carry trade will gain traction as investors gain confidence in Japanese bond prices after a selloff that began in 2022. Positioning data indicated a significant jump in net yen long positions in the week ending September 15. Following the BOJ's recent 25-basis-point rate hike, which saw two dissents and was interpreted by investors as a dovish signal, the yen's sharp decline was reportedly contained by authorities conducting rate checks in the currency market. The yen has appreciated 1.2% against the dollar month-to-date. Goh highlighted Japan's steepening yield curve, with the gap between 2- and 30-year JGB yields exceeding 200 basis points, contrasting with flattening curves in other developed markets. Eastspring, which manages $291 billion in assets, is increasing its holdings of shorter-dated dollar-denominated bonds and gradually building exposure to the ultra-long end of the Japanese curve through high-quality corporate and Samurai bonds to enhance carry.