Japan's bond yields hit 17-year highs

Benchmark 10-year Japanese government bond yields jumped to 1.8 per cent, a level last seen seventeen years ago. The sell-off ran across the whole Tokyo curve, and traders read it one way: the Bank of Japan is about to raise rates, and by a meaningful step.

From negative rates to this

The Bank of Japan spent most of the past decade holding its short rate below zero and capping the 10-year yield through unlimited bond buying. It ended both policies in March 2024, lifted its policy rate to 0.25 per cent that July and to 0.5 per cent in January this year, and has held there since. It has also been trimming its monthly bond purchases under a gradual taper plan. With the central bank buying less, the market has had to find a price for Japanese duration on its own, and the price keeps falling.

Politics has added to the pressure. Sanae Takaichi became prime minister in October promising an expansionary fiscal policy, and her cabinet approved a large stimulus package in November. For a government whose debt is more than twice the size of the economy, bigger deficits at the same time as a less accommodative central bank is exactly the mix that pushes term premiums up. Yields at the very long end, on 30- and 40-year bonds, have set records this year.

Ueda runs out of reasons to wait

The spring wage talks, known as Shunto, point to another year of big base-pay rises, and the yen is trading close to its historic lows against the dollar. Governor Ueda has little room left to put off a move. Interest rate swaps put the odds of a 25-basis-point rise at the 19 December policy meeting at 90 per cent.

The wage evidence is what the bank said it needed. Settlements in the past two rounds came in above 5 per cent, the strongest since the early 1990s, and unions are already signalling similar demands. A weak yen raises import prices and keeps inflation above the 2 per cent target, which weakens the case for patience. Ueda himself used a speech on 1 December to put a December move plainly on the table, and the curve repriced within hours.

The last time rates rose

The market has reason to take the transition seriously. The July 2024 rise, arriving just as weak American jobs data landed, set off a rapid unwinding of trades funded in cheap yen, and the Nikkei suffered its worst one-day fall since 1987 on 5 August. The Bank of Japan then signalled it would not raise rates while markets were unstable. That episode showed how much leverage had been built on the assumption of near-zero Japanese rates, and how quickly it can reverse when the assumption is questioned.

Japanese money heads home

Global bond investors have long treated Japan as a bottomless source of free funding. A 10-year yield closing in on two per cent undoes that assumption. Once domestic yields look attractive without a currency hedge, Japanese life insurers and pension funds sell foreign bonds and bring the money back, and they are already doing so.

The arithmetic that kept Japanese money abroad has flipped. A Japanese insurer buying Treasuries with the currency risk hedged pays roughly the gap between American and Japanese short-term rates for the hedge, and with the Fed's rate still near 4 per cent that cost eats most of the yield. A hedged 10-year Treasury now yields less than a 10-year JGB. Unhedged, the insurer earns more but takes the risk that the yen recovers from near record lows, which is exactly what a Bank of Japan tightening cycle would encourage. Japan is the largest foreign holder of Treasuries, so even a slower pace of buying matters at the margin.

Inside Japan the move creates clear winners. Banks, which spent years earning almost nothing on their deposits and loans, stand to widen their lending margins as short rates rise, and their shares have tracked the rise in yields. Savers finally earn something on deposits. The losers are borrowers on floating-rate mortgages, which make up most new home loans in Japan, and a government that must refinance a vast stock of debt at higher coupons. Exporters would lose some of the currency cushion that has flattered their profits if the yen recovers.

The finance ministry has already trimmed its issuance of super-long bonds this year to ease pressure at that end of the curve, a sign that officials are worried about who will buy. Every rise in yields feeds through, slowly, into the cost of servicing the national debt, which in turn makes investors more demanding about fiscal policy. That loop is new for Japan, where a captive domestic buyer base kept borrowing costs low for three decades.

Why the exodus may be slow

The case against a rush home is respectable. Repatriation has been predicted for years and has come in trickles rather than floods, because Japanese institutions hold foreign bonds to match long-dated liabilities and do not sell them lightly. A policy rate of 0.75 per cent after a December move would still sit far below inflation, leaving real rates negative. The Bank of Japan has also shown, in August 2024, that it will pause if markets wobble.

Those points slow the shift rather than stop it. The decision that matters is where new money goes each year, not whether existing portfolios are dumped, and at current yields fresh premiums and maturing holdings have a reasonable home in Tokyo for the first time in a generation. The Ministry of Finance's weekly figures on portfolio flows, the demand at super-long JGB auctions and the Bank of Japan's guidance on how far rates will rise after December will show how fast that happens.

At 1.8 per cent the JGB ends the era of free Japanese money. Treasuries and European bonds will probably lose a steady buyer over the coming year and pay for it in higher yields. The effect will show first at the long end of those markets, where Japanese insurers have been reliable buyers, and it will grow with each step the Bank of Japan takes after December.