Japan’s government bond market has emerged as a flashpoint for global financial markets, with long‐dated yields climbing toward multi‐year highs. As yields on 30‐ and 40‐year Japanese bonds approach levels not seen in over a decade, investors fear a wave of capital repatriation from overseas—including the United States—could trigger a broad unwind of yen carry trades and roil asset prices worldwide. Analysts warn that continued pressure on Japan’s bond market could potentiate significant market turbulence, exacerbating volatility in equities, currencies, and fixed‐income markets.

At the center of these concerns is the rapid ascent of yields on Japanese government bonds (JGBs). The yield on the 40‐year JGB recently touched 3.689 percent—its highest on record—before settling near 3.32 percent. Meanwhile, the 30‐year yield climbed above 2.90 percent, up more than 60 basis points since the start of the year, and 20‐year yields rose more than 50 basis points to around 2.65 percent. These moves contrast sharply with the historically low yield environment that Japanese investors have grown accustomed to under two decades of near‐zero interest rates.

The jump in longer‐dated JGB yields stems from a combination of factors, most notably the Bank of Japan’s (BoJ) decision last year to scale back its massive bond‐buying program. After years of aggressive quantitative easing intended to push yields lower and stimulate growth, the BoJ signaled a shift toward normalizing policy. While the central bank has maintained its commitment to controlling the short end of the yield curve through yield curve control, its reduced purchases of long‐dated bonds have allowed market forces to drive those yields higher. Simultaneously, pension funds and life insurers—major buyers of long‐dated debt—have largely satisfied regulatory‐driven buying requirements, leaving fewer natural custodians for supply and thereby creating a supply‐demand imbalance.

This tightening in Japan’s bond market carries broader implications. Japanese institutional investors have historically deployed trillions of yen to acquire U.S. Treasuries and other overseas assets, seeking higher interest returns abroad than their domestic alternatives. As carry trades flourished, investors borrowed cheaply in yen at sub‐1 percent rates and reinvested in higher‐yielding dollar‐denominated securities, capturing the interest‐rate differential. However, as JGB yields ascend, the attraction of financing in yen diminishes. When yields rise sufficiently to narrow or reverse that differential, borrowers on the short‐yen side face mounting losses—creating powerful incentives to unwind and convert foreign proceeds back to yen.

Market participants warn that if a critical threshold is breached—sometimes referred to as a “trigger point”—Japanese investors may abruptly repatriate capital from U.S. Treasuries, corporate bonds, equities, and other dollar‐based holdings. Macquarie analysts estimate that should Japanese 10‐year yields exceed mid‐2 percent territory sustainably, the incentive to return proceeds home could spark significant outflows from U.S. assets. For context, Japanese institutions held roughly \$1.2 trillion in U.S. Treasuries as of the latest estimates, positioning them as the single largest foreign creditor to the U.S. government. Even a partial shift of those holdings back to Japan would send shockwaves through global bond markets, driving U.S. yields sharply higher and exacerbating borrowing costs across the world.

Montley‐influenced strategies have already begun to hint at such moves. Many Japanese life insurers and pension funds have purchased minimal long‐dated JGBs in recent months, creating an echo of July 2024 when buying demand dropped to its weakest since mid‐2023. With limited domestic appetite to absorb newly issued long bonds, yields have been propelled higher. As those domestic buyers have scaled back, overseas investors have filled some gaps, but not to the extent necessary to prevent a rise in yields. Observers note that if overseas investors, including foreign central banks and global bond funds, reduce their JGB holdings—even by a few percentage points—the entire curve could be repriced substantially higher.

A more immediate concern is the unwinding of the yen carry trade. Since 2012, Japanese policies kept policy rates near zero, fostering one of the world’s steepest interest‐rate differentials with the U.S., where 10‐year Treasuries traded above 4 percent for much of 2024. At its peak, the carry trade accounted for hundreds of billions of dollars in yen‐funded investments in U.S. Treasuries, global equities, and corporate bonds. In August 2024, the BoJ’s initial shift toward rate normalization catalyzed a sudden spike in the yen’s value—rising 10 percent in weeks—and forced a sharp unwinding of these yen‐funded positions. That “sucking sound” reverberated through global markets, triggering steep declines in both U.S. Treasuries and equities.

With Japanese long yields now climbing anew, traders fear a replay—potentially even more violent. The carry trade unwind that took place last summer was largely driven by a surprise BoJ interest rate hike that pushed 10‐year yields above 1 percent and prompted rapid yen appreciation. This time, the yield surge on 20‐, 30‐, and 40‐year JGBs is more pronounced, potentially exerting sustained upward pressure on the yen as investors flock home. Albert Edwards, global strategist at a major European bank, warned that if yields continue to rise, Japanese investors will see little reason to leave money in U.S. assets when they can earn higher returns domestically. “A steep carry trade unwind could lead to a global financial market Armageddon,” he recently told intermediaries.

The prospect of a stronger yen compounds concerns. As the currency appreciates, U.S. dollar‐denominated assets held by Japanese investors become less valuable in yen terms, accelerating the incentive to sell. A rising yen also creates headaches for U.S. exporters who rely on Japanese demand—already stretched by weak growth and inflationary pressures at home. Equity markets in the U.S. and Europe, which have benefited from years of steady capital inflows from Japan, could suffer significant reversals if that flow dries up. Japan’s net external assets reached a record ¥533 trillion (\$3.7 trillion) in 2024, underscoring the scale at which Japanese capital supports global financial markets. If even a fraction of those assets are reallocated, its impact will be felt far beyond Asia.

Bearish scenarios forecast that the combined effect of higher yields, a stronger yen, and deteriorating carry trade returns will tighten global liquidity conditions at a moment when the world’s major economies are already grappling with slowing growth. David Roche, chief strategist at a leading macro advisory firm, argues that tightening financial conditions could reduce global GDP growth to near 1 percent, stoking further asset‐price declines. He contends that once Japanese money begins flowing back home in earnest, markets will face a severe squeeze—pushing up yields, depressing equity valuations, and prolonging the ongoing bear market in risk assets.

Yet not every analyst expects a sudden, dramatic unwind. Some point out that structural considerations may temper the pace of repatriation. Japanese institutions maintain significant strategic allocations to U.S. Treasuries due to longstanding economic ties and regulatory frameworks that favor stability over short‐term yield chasing. According to state pension fund disclosures, a considerable chunk of foreign investments is allocated to U.S. government bonds, partially for security and liquidity reasons. These allocations are unlikely to be abandoned wholesale; instead, many investors may opt for a gradual reduction in carry exposures, selling off riskier equity holdings or corporate credit first, while retaining strategic Treasury holdings to preserve the depth and liquidity advantages of U.S. debt markets.

Moreover, the current yield differential between U.S. and Japanese short‐term rates, while still sizeable, is narrower than it was a year ago. In mid‐2024, the spread between U.S. two‐year yields and Japanese two‐year yields reached roughly 450 basis points. Today, that gap has shrunk to closer to 320 basis points. With a smaller differential, the cost of borrowing in yen to invest in higher‐yielding U.S. instruments is less attractive. As a result, carry positions may already have been partially unwound, dampening the potential for a repeat of last year’s sudden moves. Guy Stear, head of developed markets research at a leading European asset manager, believes that an abrupt, system‐wide disruption is less likely this time—what’s under way now may be a protracted, gradual rebalancing rather than an explosive crash.

Still, many agree that the risk of broader repercussions cannot be discounted. Japanese life insurance companies and pension funds have historically accounted for more than half of demand for ultra‐long JGBs. As those regulatory buying quotas wind down, the central bank’s retreat leaves a void that foreign buyers have yet to fill. Given a scheduled issuance of ¥100 trillion in government bonds this fiscal year, the mismatch between supply and domestic demand is expected to persist. If overseas investors—particularly non‐Japanese sovereign wealth funds and global fixed‐income funds—begin to scale back their JGB holdings in anticipation of further weakness, yields could ascend even higher.

As JGB yields climb, borrowing costs for Japanese corporations and households will gradually tick upward. While the BoJ remains committed to capping 10‐year yields near its 1 percent target, the rapid ascent in yields beyond 20 years signals growing market skepticism about the bank’s willingness or ability to control the curve indefinitely. Corporates that have relied on ultra‐low‐cost financing for capital expenditure and refinancing may find their margins squeezed, potentially slowing investment in productive sectors. That, in turn, could weigh on Japan’s already anemic economic growth, as capital expenditure in the nonmanufacturing and manufacturing sectors shows signs of plateauing.

The yen’s ascension has been equally dramatic. Since the start of 2025, the currency has strengthened more than 8 percent against the dollar, fuelled partly by expectations that the BoJ will continue normalizing policy while the Federal Reserve may soon begin easing. A stronger yen effectively erodes the profits of U.S. firms whose overseas revenues are converted back into yen, as well as the value of U.S.‐based assets held by Japanese investors. Heightened volatility in foreign exchange markets, especially when combined with rising bond yields, poses a challenge for multinational corporations engaged in hedging strategies.

Against this backdrop, policymakers in Tokyo and Washington face a delicate balancing act. Japanese authorities are keen to avoid an overly rapid tightening of financial conditions that could derail the fragile economic recovery after successive quarters of sub‐2 percent GDP growth. The BoJ’s leadership has reiterated a willingness to adjust yield curve control parameters to prevent disorderly market moves, yet market watchers question the central bank’s capacity to consistently purchase the vast quantities of long bonds necessary to contain yields if investor sentiment shifts decisively.

In the United States, the Biden administration and the Federal Reserve are equally vigilant. U.S. Treasuries benefit from Japanese demand keeping yields comparatively lower; a sudden drop in foreign appetite could drive 10‐year yields sharply higher, complicating the Fed’s task of balancing inflation containment with economic growth. U.S. officials have repeatedly emphasized that stable capital flows from Japan and other major holders are critical to preserving market liquidity. While diplomatic channels remain open to discuss financial stability concerns, regulators have scant tools to prevent large‐scale private capital reallocations driven by pure yield considerations.

As markets navigate this evolving landscape, traders and fund managers closely watch JGB auctions, BoJ policy statements, and interbank funding conditions for signs of shifting sentiment. Some have looked to options markets to hedge against yen strength or unwind potential carry positions, while others have adjusted portfolio allocations to reduce exposure to long‐duration U.S. Treasuries. The widespread deployment of interest rate swaps and forward‐starting forward‐rate agreements suggests that sophisticated players are bracing for a sustained period of heightened volatility rather than a swift return to calm.

Whether Japanese bond yields stabilize near current levels or continue their upward push remains uncertain. Analysts underscore that even modest additional tightening by the BoJ—say, allowing 10‐year yields to move to 1.5 percent—could cause further shocks. Conversely, a sudden announcement that the BoJ would deepen its bond reinvestments or slow the pace of yield cap adjustments might temporarily calm markets, though at the expense of broader policy credibility.

In the near term, Japan’s bond market serves as a barometer for global risk appetite. High yield readings on the 20‐, 30‐, and 40‐year JGBs reflect a world in which investors contend with slowing growth, persistent inflation, and geopolitical uncertainty. Should Japanese investors indeed repatriate capital on a large scale, markets from New York to London to Frankfurt would likely experience sudden jolts. The potential for an outsized yen rally, accompanied by a reprice of U.S. interest rates, underscores the interconnectedness of today’s financial system—and the outsized influence wielded by Japan’s colossal pool of domestic savings.

As the carry trade unwinds and JGB yields remain elevated, global financial markets brace for potential aftershocks. What began as a domestic policy tweak by the Bank of Japan now looms as a recurring source of volatility for investors worldwide—one that could shape the trajectory of interest rates, equity valuations, and currency crosses for months, if not years, to come.

(Adapted from CryptoPolitician.com)

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