RBC warns that rising yields in Japan could significantly change global foreign exchange and bond movements. Japanese investors may choose to keep more of their money within the country because of appealing returns. For the first time since 2020, Japanese yields are now attractive for local investments. RBC forecasts that by 2026, Japanese investors could earn an extra yield of 30 to 120 basis points, depending on the investment’s maturity.

Impact on Foreign Exchange Flows

This trend will influence foreign exchange flows. RBC projects that Japan’s overnight rates could rise by about 50 basis points by the end of next year, while U.S. rates may drop by around 130 basis points. If life insurers increase their hedge ratios from 45% to 60%, as much as US$173 billion could return to the Japanese yen, boosting the currency’s strength. As Japanese yields become more attractive, domestic investors are likely to prefer keeping their funds in Japan. The yield on the 10-year Japanese Government Bond has recently stayed above 1.25%, a notable change from the near-zero rates of a few years ago. This shift indicates that the trend of Japanese capital flowing abroad in search of better returns may soon reverse. The difference in policies between Japan and the United States is becoming clearer. The Bank of Japan hinted at a possible small rate increase before the end of the year during its August 2025 meeting. Meanwhile, recent U.S. inflation data suggests that the Federal Reserve may continue easing rates into 2026. In the coming weeks, traders dealing in derivatives should consider preparing for a stronger yen. Buying call options on the JPY or put options on the USD/JPY pair set to expire within six to twelve months could be a smart strategy to take advantage of this anticipated change. After exceeding 160 earlier in 2025, the USD/JPY is already showing signs of turning as it approaches the 155 level.

Impact on US Bond Markets

This shift in capital will also affect U.S. bond markets. Japanese investors, who hold the most U.S. debt among foreign entities, might start selling their bonds. Therefore, we should explore strategies to benefit from rising U.S. Treasury yields, such as using futures contracts to short U.S. government bonds. Recent data revealed a slight decline in Japanese investments in U.S. Treasuries, which could be an early signal of a larger trend. Interest rate swaps that wager on the difference between U.S. and Japanese yields narrowing could also be a worthwhile trade. The unwinding of the significant carry trade that has influenced the market since 2022 seems to be in its early stages. With the possibility of a major currency shift on the horizon, we should brace for increased volatility. Purchasing derivatives like straddles or strangles on the USD/JPY might be a wise tactic. This strategy allows traders to benefit from a significant price movement, regardless of the direction, as the market adjusts to this global capital reallocation. Create your live VT Markets account and start trading now.

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