Japan’s record JGB yields are presenting the BOJ with a policy problem

Japan’s central bank has been left in a difficult situation as rising government bond yields risk upsetting the policy normalization process.

The Bank of Japan faces a very difficult choice: stick with its policy of raising rates and risk even higher yields and further slow the already weakening economy, or maintain or even cut rates to boost growth, which could further accelerate inflation.

Japanese government bonds reached new highs last month. On Thursday, the 10-year JGB yield hit a high of 1.917%, its strongest level since 2007. LSEG data from 1999 showed that the 20-year JGB yield reached 2.936%, a level not seen since 1999, while the 30-year reached a record high of 3.436%.

Japan abandoned its yield curve control program in March 2024, under which benchmark 10-year bond yields were capped at around 1%, as part of policy normalization that also saw the country end the world’s last negative interest rate regime.

Now, as the country weighs rising rates at a time when inflation is rising – they have remained above the BOJ’s 2% target for 43 months – the likelihood that bond yields will rise further looms large.

Anindya Banerjee, head of foreign exchange and commodities at Kotak Securities, told CNBC’s “Inside India” program that if the BOJ returns to quantitative easing and the YCC caps bond yields, the yen could also weaken and fuel imported inflation, which is already a problem.

Rising bond yields mean higher borrowing costs for Japan, further straining the country’s finances. Asia’s second-largest economy currently has the world’s highest debt-to-GDP ratio at almost 230%, according to data from the International Monetary Fund.

Add to this a government that is poised to implement the biggest stimulus package since the pandemic to reduce the cost of living and support the struggling Japanese economy, and concerns about Japan’s ballooning debt are becoming even more stark.

The 11.7 trillion yen new debt issuance to finance Prime Minister Sanae Takaichi’s supplementary budget is 1.7 times larger than that issued in 2024 under his predecessor Shigeru Ishiba, said Magdalene Teo, head of Asia fixed income research at Julius Baer.

“This underscores the challenge the government faces in balancing economic stimulus initiatives with maintaining fiscal sustainability,” Teo said. he said.

In August 2024, Termination of yen-financed leveraged carry transactions While there were sales in stocks globally due to the BOJ’s hawkish interest rate hike and disappointing macro data from the USA, Japan’s Nikkei index lost 12.4% of its value, recording its worst day since 1987.

Carry trading refers to borrowing in a currency with lower interest rates and investing in high-yielding assets; The Japanese yen is the primary currency that finances such trades, for which the country has a policy of negative interest rates.

Now, rising Japanese yields have narrowed that rate gap, raising concerns about another wave of unwinding trade and sending funds back to Japan. But experts say a repeat of the meltdown in 2024 is unlikely.

“From a global perspective, the narrowing of the Japan-US yield spread reduces the appeal of yen-financed carries, but we do not expect a repeat of systemic easing in 2024… Instead, anticipate cyclical volatility and selective deleveraging, especially if yen strength accelerates funding costs,” said Masahiko Loo, senior fixed income strategist at State Street Investment Management..

Loo notes that these structural flows come from pension funds, life insurance and retail allocations from NISA [Nippon Individual Savings Account] by fixing foreign assets, it eliminates the possibility of large-scale repatriation.

Justin Heng, HSBC’s APAC interest rate strategist, agreed, saying Japanese investors showed little sign of repatriating funds and remained net buyers of foreign bonds.

According to HSBC, they purchased 11.7 trillion yen of foreign debt between January and October 2025; This is a much higher figure than the 4.2 trillion yen purchased in all of 2024. This increase was driven mainly by trust banks and asset managers benefiting from retail inflows under the Japanese government’s tax-free investment program.

“We expect the continued decline in the cost of hedging as a result of further interest rate cuts by the Fed to encourage Japanese investors to take on more foreign bond exposure,” Heng said.