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TOKYO/LONDON (Reuters) - A worrying sign of inversion in the U.S. Treasury bond curve is dulling the appeal of the developed world’s highest-yielding bond market for foreign investors.

Overseas investors are reviewing their investments or shunning Treasuries as rates at the short end rise above those at the longer end and make it unprofitable for holders of these bonds to hedge their currency risks.

The difference between short- and long-term bond rates, or the yield curve, has contracted in recent weeks as rising U.S. interest rates meet growing doubts the world’s biggest economy may be slowing down, weighing on longer-dated yields.

And as short-term yields move higher than longer-term yields, the cost of hedging exposure to the U.S. dollar has gone up.

“There is the whole issue of hedging costs. That is the one thing that was inconsequential at the start of the year but now it is sizeable,” said Paul O’Connor, head of multi-asset at Janus Henderson in London, whose firm manages $378.1 billion in assets.  

“You are knocking off a substantial part of U.S. yields when you buy from the UK perspective and hedge back that exposure. When we buy government debt, we always hedge it. You don’t want to take the FX risk,” he said.

The U.S. Federal Reserve has raised rates eight times since late 2015 and looks set to hike them again next week even as other global central banks stay shy of normalizing policy, causing a significant gap to open up in short-dated interest rates.

The European Central Bank and the Bank of Japan have both kept interest rates below zero percent, while the Bank of England has raised rates only twice from its record low near...

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