RBC suggests that rising Japanese yields may cause a major shift in global foreign exchange and bond flows. Domestic investors in Japan are likely to retain more funds locally due to attractive returns.
For the first time since 2020, Japanese yields offer enough appeal for domestic investment. RBC predicts that by 2026, Japanese investors might achieve 30 to 120 basis points of excess yield, depending on maturity.
Impact on Foreign Exchange Flows
This trend will affect foreign exchange flows. RBC forecasts Japan’s overnight rates to increase by about 50 basis points by next year’s end, while US rates might decrease by around 130 basis points. If life insurers boost hedge ratios from 45% to 60%, as much as US$173 billion could flow back into the Japanese yen, strengthening the currency.
With Japanese yields becoming more attractive, we see domestic investors starting to favor keeping their money at home. The 10-year Japanese Government Bond yield has been holding firm above 1.25% in recent weeks, a significant shift from the near-zero rates we saw just a few years ago. This trend suggests the historic outflow of Japanese capital in search of foreign returns is set to reverse.
The policy divergence between Japan and the United States is becoming clearer, adding fuel to this view. The Bank of Japan’s statements from their August 2025 meeting hinted at another small rate hike before year-end. Conversely, the latest U.S. inflation data reinforces expectations that the Federal Reserve will continue its easing cycle into 2026.
In the coming weeks, derivative traders should consider positioning for a stronger yen. Buying call options on the JPY, or put options on the USD/JPY pair, for expirations in the next six to twelve months could be a strategic way to capture this expected move. After peaking above 160 earlier in 2025, the USD/JPY has already shown signs of turning as it tests the 155 level.
Impact on US Bond Markets
This capital shift will also impact U.S. bond markets as Japanese investors, who are the largest foreign holders of U.S. debt, may begin to sell their holdings. We should therefore consider strategies that profit from a rise in U.S. Treasury yields. This could involve using futures contracts to short U.S. government bonds.
Data from earlier this year already showed a slight decrease in Japanese holdings of U.S. Treasuries, a small but potentially significant early signal. Interest rate swaps that bet on the spread between U.S. and Japanese yields narrowing could also become an effective trade. The unwind of the massive carry trade that defined the market since 2022 appears to be in its early stages.
Given the potential for a major currency realignment, we should expect a significant increase in volatility. Buying derivatives like straddles or strangles on the USD/JPY could be a prudent strategy. This allows traders to profit from a large price swing, regardless of the ultimate direction, as the market digests this fundamental global capital shift.
