Investing.com — A major reversal of the yen carry trade remains highly unlikely despite surging Japanese government bond yields, according to a UBS research report.
In an October 14 report, UBS analysts said concerns about unwinding yen-funded investments have intensified following a sharp sell-off in Japanese government bonds.
However, the bank’s rates and foreign exchange strategists assigned a very low probability to a significant reversal, arguing that the trade remains attractive despite rising Japanese borrowing costs.
The yen carry trade involves borrowing in Japan’s relatively low-interest-rate currency and investing in higher-yielding assets overseas. A reversal could force investors to sell foreign assets and repurchase yen, potentially disrupting global markets.
UBS noted that Japanese bond yields have risen approximately 140 basis points over the past two months, reflecting broader pressure on government debt markets.
Nevertheless, yields have also increased globally, preserving the interest rate differentials underpinning carry trade strategies.
The bank expects the yen to remain weak, while its Japanese macroeconomic team forecasts Bank of Japan interest rates peaking around 2% within 12 months.
That compares with market expectations for further tightening.
UBS also examined which emerging markets could face disruption if Japanese investors began repatriating capital.
The United Arab Emirates, Singapore, Australia, South Africa and India have relatively high Japanese equity ownership compared with their market capitalisation, potentially exposing them to changing investment flows.
Historically, Korean and Brazilian equities have been particularly sensitive to rising Japanese government bond yields.
However, South African, Korean and Thai equities have tended to outperform during periods of yen appreciation, suggesting an uneven impact across markets.
Materials stocks have also historically benefited from yen strength, according to the analysts.
Despite these risks, UBS maintained a constructive outlook on emerging-market equities, citing strong earnings growth and more reasonable valuations following the June-July sell-off.
The bank identified Korea, Brazil and China as its preferred markets, arguing that improving corporate earnings could offset risks from tighter global financial conditions.
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