Japan's Bond Spasm Hits A World Without Safe Havens

Latest stories

How SE Asia can break China's rare earth monopoly

Sugon, its suppliers hit by US sanctions, to merge with Hygon

Russia sanctions probably backfired, as in apartheid South Africa

All that debt issuance helped Japan grow modestly year after year. And the BOJ's aggressive JGB purchases - it holds well over 50% of all outstanding securities- helped maintain calm in the market. Until now, it's kept JGB yields from getting out of line.

The BOJ's tapering policy was going well enough. Since July 2024, Governor Kazuo Ueda has been cutting purchases by 400 billion yen ($2.8 billion) each quarter. The BOJ even managed to hike official rates to 0.5%, a 17-year high.

Then Trump 2.0 arrived to launch a trade war with every economy of scale. The tariffs triggered near-unprecedented turmoil first in US Treasury securities and then in debt markets everywhere. Including Japan, where yields have spiked in headline-grabbing ways.

The volatility culminated last week with a 20-year bond auction that absolutely flopped. The typically routine sale of $6.9 billion issues maturing in 2045 drew the least interest since 2012. The“tail,” the gap between the average and lowest-accepted prices, was the worse since 1987.

Suddenly, #JGBCrash was trending in Asian cyberspace. It was Tokyo returning the favor, sending shockwaves back toward the US. Earlier this week, US Treasury Secretary Scott Bessent said worries about Japan were indeed pushing US yields higher.

Some argue Japan worries are much ado about nothing. For example, Japanese Finance Minister Katsunobu Kato's team managed to tame markets by signaling a shift in bond issuance toward shorter-dated securities.

It helps explain why a less-than-stellar 40-year bond sale on Wednesday didn't slam world markets. Markets are betting that, for now, Tokyo is on top of things.

“We maintain our long-standing view that the challenges in the JGB market are technical rather than structural, says Masahiko Loo, senior strategist at State Street Global Advisors.“These issues are largely addressable through adjustments in issuance volume or composition.”

Loo adds that“we believe the concern on loss of control over the super-long end is overblown. Around 90% of JGBs are domestically held, and the“don't fight the BOJ/Ministry of Finance” mantra remains a powerful anchor. Any perceived supply-demand imbalance is more a matter of timing mismatches, which is a technical dislocation rather than a fundamental flaw. We expect these imbalances to be resolved as early as the third quarter.”

The MOF's announcement that it might reduce the size of bond issues, Loo says,“reinforces our view.”

Yet risks abound. In a note to clients, Macquarie Bank analysts warn that rising JGB yields could be a“trigger point” that catalyzes a wave of capital repatriation with Japanese investors pulling funds from dollar assets.

Albert Edwards, global strategist at Societe Generale, goes further, arguing a Japanese yield surge could“trigger a global financial market Armageddon.”

Goldman Sachs analysts think the JGB market is a“canary in the global duration coal mine.”

Realizing that, and not wanting to trigger a global meltdown, Tokyo may reduce issuance of super-long JGBs in July, easing market concerns, says Katsutoshi Inadome, strategist at Sumitomo Mitsui Trust Asset Management.

However, he adds,“this offers only temporary relief and won't lead to a decline in Japan's debt balance. With the MOF likely doing its part, politicians now need to make efforts to avoid increasing debt.”

The timing of all this could scarcely be worse. Carlos Casanova, economist at Union Bancaire Privée, says that the market has been pricing in the possibility of slower growth and higher inflation.

“Compounded with technical factors in a notably illiquid market,” he says,“this has exerted upside risks on JGBs, with the 10-year bond picking up to 1.50% and the 30-year soaring to 3.16%.

Yet where JGB yields go could have major implications globally. George Saravelos, head of FX research at Deutsche Bank, called the recent divergence between US yields and the yen exchange rate the“single most important market indicator of accelerating US fiscal risks” because it shows foreign buyers are jittery about the US Treasury market.

“The Japanese yen is strengthening even as US yields are rising,” Saravelos says.“We consider this as evidence that foreign participation in the US Treasury market is declining.”

All this has the BOJ throttling back on rate hikes. Over the last two years, Governor Ueda's team managed to boost the benchmark to the highest since 2008.

Now, fears that Japan is skirting stagflation are getting in the way. GDP shrank 0.7% in the first quarter, while consumer price inflation is running at a 3.6% rate. That's nearly double the BOJ's 2% target.

Recent market turmoil is“adding to the Bank of Japan's challenge of balancing price pressures against growth headwinds from US tariffs,” UBS analysts write in a report. UBS thinks the BOJ's next tightening move won't come until 2026.