Japan Yield Curve Steepening Unleashes Reverse Carry Trade Opportunity

The Bank of Japan's interest-rate hikes have created a 'reverse carry' trade opportunity for overseas investors, according to Rong Ren Goh, fixed income portfolio manager at Eastspring Investments.

A steep rise in Japanese bond yields has made the traditional yen-funded carry trade less compelling, as markets expect Japan's policy rate to eventually reach around 2% from its current level of 1.25%, said Goh.

The 'reverse carry' trade involves buying ultra-long Japanese government bonds and hedging yen exposure back into dollars or another developed-market currency, potentially giving investors higher yields versus comparable bonds in their home markets.

Goh noted that the 30-year Japanese government bond above 4% gives an FX-hedged yield 100 to 200 basis points higher than the base currency equivalent when swapped in any developed-market currency, including the dollar.