US markets were closed on Monday due to the Memorial Day holiday. But what is going on in the Japanese bond market because, trust me, these developments could develop into a major risk to US treasuries, and by extension global yields.
JGB yields surged last week as BOJ shifted policy gears, exposing cracks in market liquidity and testing
investor confidence. With fiscal health intact but global carry trades at risk, Japan’s bond market looms as a potential disruptor in H2. Japan’s 30-year government bond yield surged to a record high of 3.18%. Since the pandemic, long-term JGB yields have been on an upward trend. With inflation and wage growth picking up, the Bank of Japan has been moving toward policy normalization. In recent years, the BOJ has ended yield curve control (YCC), started raising rates, and even begun quantitative tightening (QT)—all contributing to the steady rise in JGB yields.
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- Figure 1: Japan 10-year Govt. Bond Yield
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- Figure 2: Major Economies’ Holdings of US Debt
Japan’s bond market is facing growing stress. The BOJ’s latest Bond Market Survey showed the JGB market
functioning index fell sharply to -44 in Q2, the lowest since May 2023. Investor confidence took another hit after Japan’s 20-year government bond auction on May 20 showed weak demand. The bid-to-cover ratio dropped to 2.50, the lowest since 2012. The lowest accepted price was ¥98.15—far below the expected ¥99.80. The tail widened to ¥1.14, the largest since 1987, signaling poor liquidity and weak interest.
What is everyone so worried about? Japanese banks’ yen lending abroad—a proxy for medium-term carry trade magnitude—has surged to $1 trillion (145 trillion yen), often to asset managers, driven by rate differentials. Unlike futures traders, asset managers may unwind positions gradually, raising the medium-term risk of reversal. Rising JGB yields may prompt major Japanese life insurers to increase their JGB holdings. To fund this, they could sell US Treasuries. Since Japan is the largest foreign holder of U.S. debt, any shift in its holdings could have ripple effects across global markets.
Moving forward, there are several key dates ahead that could significantly impact the yen and Japan’s bond market:
- June: The Bank of Japan will announce its balance sheet reduction plan for next year. Markets currently expect a gradual pace—around a 6–7% reduction over two years. However, if the BOJ opts to speed up the process, it could put pressure on global markets.
- July: The 90-day tariff pause expires. If Trump resumes imposing high tariffs, it could trigger renewed global market volatility.
- Q3: If the U.S. Congress passes both the tax cut and debt ceiling bills, the Treasury is likely to increase long-duration bond issuance, pushing global yields higher.
- Q3–Q4: Markets expect the Fed to cut rates twice and the BOJ to hike once in the second half. If either central bank turns out to be more hawkish than expected, it could unsettle markets.
- Bottom line: Japan’s financial markets will be a key area to watch in the second half of the year. With rising global uncertainty, market tolerance for surprises is falling. In this environment, close attention should be paid to the JGB market, alongside inflation trends and BOJ policy signals.
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