Steepening Yield Curve Creates Reverse Carry Trade Opportunity in Japan

Japan's yield curve is steepening at an unprecedented rate, creating an opportunity for overseas investors to engage in a 'reverse carry' trade. According to Rong Ren Goh, fixed income portfolio manager at Eastspring Investments, this shift could make Japan's own bonds more attractive than those of other developed markets.

Goh noted that buying ultra-long Japanese government bonds and hedging yen exposure back into dollars or another developed-market currency can give investors higher yields compared to their home markets. For example, a 30-year Japanese government bond above 4%, swapped in any developed-market currency, offers an FX-hedged yield 100 to 200 basis points higher than the base currency equivalent.

The traditional yen-funded carry trade is no longer as compelling, Goh said, as markets expect Japan's policy rate to eventually reach around 2% from its current 1.25%. Eastspring is adding shorter-dated dollar-denominated bonds while favouring the ultra-long end of the Japanese curve, where it is gradually building exposure through high-quality corporate and Samurai bonds.