Japan’s government bond market long seen as one of the world’s most stable was jolted this week by a sharp selloff that reverberated across global financial markets. Yields on benchmark 10-year Japanese government bonds (JGBs) jumped 8.5 basis points in just two days, marking the steepest rise since the Bank of Japan (BOJ) loosened its yield cap in 2022.
The abrupt move has unsettled investors precisely because Japan’s bond market is vast, deeply interconnected with global portfolios, and typically characterised by low volatility. Even modest yield spikes in JGBs can trigger large reallocations in global bond and currency markets.
Yuichiro Tamaki, leader of the Democratic Party for the People (DPP), warned that authorities must act “decisively” to counter what he described as “abnormal” market moves.
Political Trigger: Fiscal Expansion Fears Resurface
The selloff was triggered by comments from Prime Minister Sanae Takaichi, who announced plans to call a snap general election on February 8 and pledged to suspend an 8% levy on food sales for two years. She also signalled a shift away from what she termed “excessively tight fiscal policy.”
Markets interpreted the announcement as a clear sign of looming fiscal expansion, raising fears of increased debt issuance in a country already carrying the highest public debt burden in the developed world. Investors reacted swiftly, selling off longer-dated bonds particularly super-long maturities on concerns that supply would surge just as the BOJ is scaling back its support.
Opposition’s Prescription: Bond Buybacks and Issuance Cuts
Tamaki argued that policymakers have tools to calm markets if volatility becomes excessive. These include:
- Buying back outstanding government bonds, particularly in the super-long segment
- Reducing issuance of 40-year JGBs, where investor appetite has weakened
- Slowing the pace of the BOJ’s tapering of bond purchases
While the DPP is smaller than the main opposition bloc, its parliamentary influence especially its swing vote in key economic legislation gives Tamaki’s remarks political weight.
Monetary Policy at a Crossroads
The turmoil comes at a delicate moment for the BOJ. After ending a decade of ultra-loose monetary policy in 2024, the central bank has been carefully normalising policy, raising short-term interest rates to 0.75% last month and tapering bond purchases.
Tamaki broadly endorsed this trajectory, saying the BOJ was “moving in the right direction,” but stressed that future rate hikes should remain contingent on sustained wage growth particularly among small and mid-sized firms. He suggested wage gains of around 5% would justify continued tightening.
Markets currently expect the BOJ to hike rates roughly twice a year, with most analysts seeing the next move in July and a policy rate of 1% or higher by September.
Yen in the Crosshairs: FX Intervention Back on the Table
Bond market stress has spilled into currency markets. Since Takaichi took office in October, the yen has weakened roughly 8% against the dollar, briefly touching an 18-month low of 159.45 per dollar its weakest level since Japan’s last currency intervention in July 2024.
Tamaki warned that if efforts to stabilise bond yields end up weakening the yen further, authorities should not rule out foreign exchange intervention. This underscores a key dilemma for policymakers: actions that support bonds and growth may undercut the currency, potentially stoking imported inflation.
Analysis: Why This Matters Beyond Japan
This episode highlights a fragile balancing act in Japan’s post-stimulus era. Markets are testing whether fiscal discipline will hold just as the BOJ withdraws from its long-standing role as the dominant buyer of government bonds.
The sharp reaction suggests investors are increasingly sensitive to political signals that hint at looser fiscal policy. Unlike in the past, when BOJ support muted market responses, today’s environment leaves less room for policy missteps.
For global markets, rising JGB yields matter because Japanese investors are among the largest holders of foreign bonds. Sustained yield increases at home could trigger capital repatriation, pushing up yields abroad and strengthening volatility across asset classes.
In that sense, what began as a domestic political announcement has quickly evolved into a broader test of Japan’s credibility in managing the transition away from extraordinary monetary and fiscal support without unsettling markets that have grown accustomed to stability.
With information from Reuters.