Japan's Steep Yield Curve Unleashes 'Reverse Carry' Trade Opportunity

Japanese bond yields have surged, creating an opportunity for 'reverse carry' trades as investors seek higher returns. According to Rong Ren Goh, fixed income portfolio manager at Eastspring Investments, this shift in market dynamics is driven by the Bank of Japan's interest-rate hikes and a steepening yield curve.

The traditional yen-funded carry trade has become less compelling due to expected policy rate increases in Japan. This has led to a 'reverse carry' opportunity where investors buy ultra-long Japanese government bonds and hedge their yen exposure back into dollars or other developed-market currencies, potentially earning higher yields compared to comparable bonds in their home markets.

Goh noted that buying the 30-year Japanese government bond above 4% and swapping it in any developed-market currency can give an FX-hedged yield 100-200 basis points higher than the base currency equivalent. Eastspring is gradually building exposure to ultra-long Japanese bonds, favoring high-quality corporate and Samurai bonds for additional credit spread.