UBS analysts assessed the probability of a large-scale yen carry trade reversal as extremely low, despite the rise in Japanese bond yields.
UBS analysts in a report dated October 14 concluded that the probability of a significant reversal of the yen carry trade remains extremely low. Concerns about this intensified after a sharp sell-off in Japanese government bonds and a noticeable rise in their yields.
The bank's strategists on rates and currencies note that the carry trade strategy retains its attractiveness. It involves borrowing yen at a low interest rate and investing the funds in higher-yielding assets abroad. A reversal could lead to sales of foreign assets and purchases of yen, but UBS considers such a scenario unlikely.
Over the past two months, Japanese bond yields have risen by approximately 140 basis points. At the same time, yields have also risen in global markets, which preserves the interest rate differential on which the strategy is based. UBS analysts expect the yen to remain weak. Their forecast is that the Bank of Japan's rate will peak at around 2% over the next 12 months — below market expectations.
UBS also assessed the vulnerability of emerging markets. Taiwan, India, Thailand and Indonesia have a relatively high share of Japanese equity investments. Taiwanese and Indian equities have historically been sensitive to rising Japanese bond yields. At the same time, South African, South Korean and Australian equities, as well as commodity companies, have typically performed better when the yen strengthens.
Despite the risks, UBS maintains a positive view on Australian equities, citing corporate earnings growth and attractive valuations after the sell-off in June-July. Among priority markets, the bank highlights South Korea, Brazil and Australia.