Japan’s Influence and Impact on Global Bond
Markets
By the Curmudgeon
Introduction:
The Japanese government bond market (JGB) is
currently experiencing a period of volatility and uncertainty, primarily driven
by a combination of domestic and global factors. At 7.8 trillion, the JGB is one of the
largest in the world. Therefore, its performance has a ripple effect on all
global bond and fixed income markets.
That’s the major theme of this article, but
first a quick recap:
Last Wednesday, the Japanese
government’s $3.5B auction of 40-year bonds had the weakest demand in almost
one year. The bid-to-cover ratio — the number of bids received against
securities offered — was only 2.2, the lowest level since July 2024. It comes
after last week’s disappointing auction of 20-year Japanese government debt,
which saw the weakest demand since 2012.
The
rise in yields is a reflection of what some
traders have called a “buyers’ strike” by Japanese life insurers and
other domestic participants. That
dynamic pushed yields on all Japanese government bonds higher.
As of May 30, 2025, the yield on
Japan’s 30-year government bond was 2.97%. Earlier this week, it hit a
high of 3.19%, which is significantly higher than the long-term average yield
of 1.71%. The 30-year yield was below
2.3% at the start of the year, as can be seen in the chart below.
Chart Courtesy of Trading Economics
Japan’s government bond market turmoil has subsided slightly in recent
days. But like in the U.S., it exposes the structural imbalance between
supply and demand for Japan’s government debt, which many analysts believe
will weigh heavily on future JGB prices.
BoJ Yield Curve Control and
Tapering of Debt Purchases:
The Bank of Japan’s (BoJ)
“yield curve control” program, which capped JGB yields, seems to have acted as
an anchor for global bond yields for much of the past decade.
Last week, Japan’s Ministry of
Finance suggested one possible way to stabilize longer-term yields is to reduce
long-term debt issuance and selling more shorter-term notes to fund Japan’s
ever increasing debt stockpile. That
would be a reversal of the Finance Ministry past policy of skewing debt
issuance heavily towards the long end to lock in low borrowing costs for many
years. That’s clearly depicted in this
chart:
The Japanese government bond
(JGB) yield curve shows the connection between JGB interest rates and their
maturities.
Chart courtesy of Trading View
QE Tapering:
Meanwhile, the biggest buyer of Japanese debt - the BoJ- is reducing
its bond purchases (QE) by Y400bn ($2.8bn) per quarter and plans to continue
that pace until March 2026.
Incredibly, Japan’s central bank
has built an unorthodox, market-distorting position where it holds ~52% of the
government debt market. For many years,
investors have questioned how the authorities plan to juggle the political and
financial realities of a gross debt-to-GDP ratio that has risen to almost
250%.
[In
contrast, the U.S. debt to GDP ratio is projected to reach 124.4% by the
end of 2025 according to Trading Economics.]
Japan’s Finance Ministry and
central bank (BoJ) face important decisions in the coming weeks as they decide
how best to deal with a surge to record highs in long-term borrowing costs and
the prospect of a shrinking investor base for the country’s debt.
A Critical Week Coming Soon for
Japan’s Bond Market:
Analysts say the week of June
16th will be crucial in determining the trajectory of
rates in Japanese government bond market. That week includes a two-day meeting
of the BoJ’s Monetary Policy Committee, where it will review the past
year of reduced bond buying. Some market participants believe the BoJ committee
may decide to slow the pace at which it tapers its bond purchases, in an effort to keep a lid on yields.
Later that week, Japan’s
Ministry of Finance is scheduled to discuss debt issuance plans with market
participants and could decide to scale back sales at the super-long end.
Benjamin Shatil, senior economist
at JPMorgan, said the BoJ appears to be behind the curve as Japan enters
its 4th year with headline inflation above its 2% target. It’s 3.6%
now vs 2.5% one year ago. In addition, Shatil noted the massive Government Pension Investment Fund
has not raised its allocation to domestic assets over foreign assets. Also, the rapid tightening of liquidity
in the commercial banking sector. “It all begs the question — why buy?” he
concluded.
Shinichiro Kadota, a rates and FX
strategist at Barclays in Tokyo, said that following Wednesday’s weak
auction of 40-year debt, the key would be the finance ministry’s communications
on its plans for future issuance. He
noted that the super-long end of the JGB market was expressing issues that had
been brewing for some time, but, like BoJ normalization and the potential need
for Japan to raise defense spending, had become more material.
Kadota opined that it was
unlikely the BoJ would pull back on reducing JGB purchases. “There may be some tweaks . . . but
the solution has to be the Ministry of Finance
[reducing] issuance,” he added.
Japan’s Influence and Impact on
Global Bond Markets:
Backgrounder:
Japanese financial institutions have accumulated a huge hoard of U.S.
government bonds over the past few decades to counteract the lack of yields at
home. As
of April 2024, FOX 9
Minneapolis-St. Paul reports that Japanese financial
institutions held approximately $1.125 trillion in U.S.
government debt. That makes Japan the largest foreign holder of U.S.
debt. Overall, Japan’s net external assets hit an all-time
high in 2024 at 533.05 trillion Yen ($3.7 trillion).
Thomas Mathews, head of Asia
Pacific markets at Capital Economics said, “We’ve been skeptical of
claims that Japanese investment (overseas) is about to flood back home due to
higher local yields. But that’s because we thought reduced short-term FX
hedging costs (thanks to a relatively flatter JGB curve) would outweigh the
effects of higher yields, making foreign bonds more attractive on a that
basis.”
“Indeed, we saw something like
the reverse of this in 2022 when the US curve was flattening; despite higher
yields abroad Japanese residents sold foreign bonds. But if the JGB (yield)
curve is steepening, e.g. due to fiscal/supply-demand concerns, then this
argument holds less weight.”
The steepening of Japan’s
yield curve is largely due to a key structural factor: Japanese life
insurance companies — a key source of demand for 30- and 40-year JGBs — have
largely met their regulation-driven buying requirements, according to Eastspring Investments’ portfolio manager in
the fixed income team, Rong Ren Goh.
Mathews continued, “Our sense is
that, in this case, the large pool of Japanese investment abroad may have
helped keep a lid on JGB yields, albeit at the potential expense of bonds
elsewhere. If Japanese investors were to sell foreign bonds at scale, it
could push global term premia up further.” The Curmudgeon explained term
premium here and
why it has increased here.
Dangers of the Reverse Carry
Trade:
For a very long time, analysts have warned that a potential
large-scale reversal of the Japanese Yen (JPY) - U.S. dollar “carry
trade [1.]” was imminent.
….………………………………………………………………………………………………
Note 1. The Japanese Yen (JPY) - U.S. $ carry trade
is difficult to size precisely due to the global nature of the trade and the
variety of instruments used. Estimates range from $764 billion to $4 trillion,
with some suggesting it could be even larger.
….………………………………………………………………………………………………
Explanation: Years of low short term Japanese rates (currently
0.5% but negative one-year ago) and low JGB yields encouraged Japanese
investors and hedge funds to borrow JPY to seek higher returns abroad. In particular, in
U.S. Treasuries, corporate bonds and stocks. That transfer of assets is known
as the “carry trade.”
Rising JGB yields or a stronger
Yen could cause those investors/ speculators to unwind (i.e. reverse) the
carry trade by selling U.S. dollar denominated assets to repatriate their
capital. That would put upward pressure on global bond yields, especially those
in the U.S.
Details: When
the JPY- U.S. $ carry trade unwinds, investors sell U.S. assets to convert the
proceeds back into JPY to repay their loans.
That selling pressure on U.S. bonds drives their prices down and pushes
their yields up. Higher U.S. bond yields increase borrowing costs for the U.S.
government, corporations, and consumers (e.g., mortgages, car loans). This
would tighten financial conditions and slow down economic activity.
Many JPY carry trades are highly
leveraged. When the JPY strengthens rapidly or interest rate differentials
narrow, investors/ speculators may face margin calls. To meet those margin
calls and reduce their exposure, they are forced to liquidate assets quickly,
especially U.S. stocks and bonds.
Michael Gayed, a portfolio manager and publisher of the Lead-Lag Report, has for years
insisted that a reversal of the JPY - U.S. $ carry trade poses a significant
and underappreciated risk to U.S. financial markets. He has repeatedly warned
about its potential to trigger market volatility and even a broader downturn in
U.S. stocks and bonds.
Gayed views Japan's monetary
policy and the potential for a sudden shift, as a "ticking time
bomb." If confidence in Japan's traditionally safe assets craters, he believes confidence in the global market
could follow leading to sharp declines in financial asset prices.
End Quote:
Should Japanese government bond
yields continue to climb, the move could “trigger a global financial market
Armageddon,” said Albert Edwards, global strategist at Societe Generale Corporate
& Investment Banking.
“If
sharply higher JGB yields entice Japanese investors to return home, the
unwinding of the carry trade could cause a loud sucking sound in U.S. financial
assets,” Edwards added.
….……………………………………………………………………………………………………….
Stay calm (easier said than done), healthy and
well. Till next time…..
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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