Japan’s borrowing costs surge to a 30-year high, as concerns about a debt crisis roil global bond markets

Japan government bonds face continuous sell-off, with long-end yields surging to levels not seen in decades. Market concerns about Japan’s fiscal sustainability are intensifying.

In the Asia-Pacific session on Thursday, Japan’s benchmark 10-year government bond yield rose to 2.883%, the highest level since 1996.

Meanwhile, the 40-year government bond yield climbed by 5 basis points to 4.055%, while the 30-year yield has already broken above 4% this year, nearing the all-time intraday high hit in May.

A 14-year, total-scale fiscal spending plan of about $2.3 trillion led by Prime Minister Hayao Takaki is seen by investors as the main driver behind this round of long-end Japanese government bond sell-off.

Although the Bank of Japan raised its policy rate to 1% last month, it has remained cautious about further tightening. Combined with the ongoing weakening of the yen, market sensitivity to fiscal risk has risen significantly. Several fund managers warn that if conditions worsen further, anomalies in Japanese government bond yields could spill over into global bond markets, increasing financing pressure on other major economies.

Fiscal concerns layered with hopes of easing put long-end rates under pressure

The core contradiction in this round of Japanese government bond sell-off lies in the conflict between fiscal expansion and the normalization of monetary policy.

Aberdeen investment director Alex Everett said:

The Bank of Japan remains cautious about further tightening. The yen’s continued weakness and lingering concerns about fiscal policy, when combined, make the long-end of the government bond yield curve especially fragile.

The market’s pricing for long-term risk is already clearly reflected. The term spread between Japan’s 10-year and 2-year government bond yields widened from less than 1 percentage point in April to 1.4 percentage points now. By contrast, the corresponding spreads in major bond markets such as the United States and Germany have recently been flat or narrowed, forming a stark contrast.

Ultima Markets’ senior analyst Elon Gu said that a 1.4% spread is a new high in three decades, meaning the market is aggressively re-pricing risk regarding Japan’s heavy forward debt burden. Aviva Investors’ head of fixed income Fraser Lundie said:

Inflation can no longer be ignored, and the scale of government borrowing remains large. The Bank of Japan is still moving forward with policy normalization. This combination has pushed the market’s sensitivity to fiscal dynamics to a peak not seen in many years.

Large debt burden, “debt trap” risk emerges

Rising borrowing costs in Japan are amplifying its already elevated sovereign debt risk.

Japan’s sovereign debt is equivalent to more than 200% of GDP. Goldman Sachs senior economist Tomohiro Ota warned that Japan could fall into a “vicious cycle”—fiscal concerns raise interest expense, further worsening fiscal pressure. Aegon Asset Management chief investment officer Stephen Jones said:

The current situation reflects that Japan has accumulated the world’s largest sovereign debt stock under the assumption that “money is always free.” The market is now actively breaking that assumption… Tokyo must bear costs unprecedented for a generation—both to refinance the past and to raise funding for the future.

Societe Generale rate strategist Stephen Spratt warned that Japan’s government borrowing costs could rise faster than the rate of revenue growth, ultimately leading to a deterioration in debt dynamics. He said:

We think the critical point is somewhere where the 10-year yield breaks above 3%. But once it hits 3%, the market will start questioning it.

Some institutional investors worry that if Japanese government bond yields rise sharply, capital flowing back from other sovereign bond markets could lift global yields overall, further tightening financing conditions in places like the UK. Earlier this year, the UK’s long-term borrowing costs had already risen to their highest levels in decades.

Whether current pressure in Japan’s bond market evolves into a systemic shock depends on the pace of adjustments to the Bank of Japan’s policy stance, as well as the specific implementation of the fiscal plans in the Takaki cabinet. The market nerves are highly stretched.

Yen and bonds move lower together; unusual signals draw attention

This year the yen and the price of Japanese government bonds have fallen in sync, but typically these two asset classes tend to move in opposite directions due to interest-rate expectations.

Despite repeated intervention by the Bank of Japan earlier, on Thursday the yen depreciated again to 162.46, falling to a 40-year low.

Analysts believe that the simultaneous pressure on both currency and bonds shows the market is questioning not only Japan’s monetary policy stance but also the credibility of its fiscal outlook—creating a negative feedback resonance between the two.

On the policy front, at last month’s meeting the Bank of Japan announced it will stop reducing the monthly pace of bond purchases next year and keep it at about 2 trillion yen (about $12.5 billion).

Unlike central banks such as the Federal Reserve and the Bank of England, which have started shrinking their balance sheets, the Bank of Japan is still continuously buying bonds. To a certain extent, this supports stability in the government bond market.

However, this approach has also drawn criticism. Some investors worry that Japan is sliding into a so-called “fiscal dominance” dilemma, where policy interest rates are artificially kept low to dilute government debt via inflation. If Japan’s large holdings of financial assets were included, its net debt-to-GDP ratio would be close to 100%.

MUFG’s Lee Hardman said Japan’s caution in raising rates is reinforcing the market’s “perception” of this strategy.

(Editor: Wenjing)

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