A major reversal of the yen carry trade remains unlikely despite rising yields, according to a recent UBS research report. The report, released on October 14, acknowledged growing concerns about unwinding yen-funded investments following a sharp sell-off in Japanese government bonds. However, UBS analysts argued that the carry trade remains attractive, even with higher borrowing costs in Japan.
The yen carry trade involves borrowing in yen, which has relatively low interest rates, and investing in higher-yielding assets abroad. A reversal could lead to selling foreign assets and repurchasing yen, potentially disrupting global markets. UBS noted that Japanese bond yields have risen by approximately 140 basis points over the past two months, reflecting broader pressure on government debt markets. Despite this, global yields have also increased, maintaining the interest rate differentials that support carry trade strategies.
UBS expects the yen to stay weak and forecasts that Bank of Japan interest rates will peak around 2% within the next 12 months. This outlook contrasts with market expectations of further tightening. The bank also identified emerging markets that could be affected if Japanese investors repatriate capital, including the United Arab Emirates, Singapore, Australia, South Africa, and India. Historically, Brazilian equities have been particularly sensitive to rising Japanese government bond yields, while Korean and Chinese equities have tended to outperform during periods of yen appreciation.
Despite these risks, UBS maintained a positive outlook on emerging-market equities, citing strong earnings growth and more reasonable valuations following the June-July sell-off. The bank highlighted Korea, Brazil, and China as preferred markets, suggesting that improving corporate earnings could offset risks from tighter global financial conditions.