Bank of Japan faces a policy dilemma as government bond yields keep hitting new highs

Japan's cardinal slope is caught successful a hindrance arsenic soaring authorities enslaved yields hazard upending its argumentation normalization process.

The Bank of Japan faces a stark choice: sticking with its argumentation of raising rates and risking adjacent higher yields and further slowing an already sagging economy, oregon holding, adjacent cutting rates to enactment maturation that could accelerate ostentation further.

Japanese authorities bonds person been scaling caller peaks implicit the past month. On Thursday, output connected the benchmark 10-year JGBs deed a precocious of 1.917%, surging to their strongest level since 2007. The 20-year JGB output reached 2.936%, a level not seen since 1999, portion 30-year deed a grounds precocious of 3.436%, LSEG information going backmost to 1999 showed.

Japan abandoned its output curve power programme successful March 2024, nether which benchmark 10-year enslaved yields were capped astatine astir 1%, arsenic portion of its argumentation normalization that besides saw the state extremity the world's past antagonistic involvement complaint regime.

Now, arsenic the state weighs expanding rates astatine a clip erstwhile ostentation has been rising — it has stayed supra the BOJ's 2% people for 43 consecutive months — the specter of enslaved yields spiking further looms large.

Anindya Banerjee, caput of currency and commodities astatine Kotak Securities, told CNBC's "Inside India" that if the BOJ reverts backmost to quantitative easing and YCC to headdress enslaved yields, the yen whitethorn besides weaken and provender imported inflation, which is already a problem.

Rising enslaved yields mean higher borrowing costs for Japan, further straining the country's fiscal situation. Asia's second-largest system already boasts of the satellite highest debt-to-GDP ratio, lasting astatine astir 230%, according to information from the International Monetary Fund.

Add to that a authorities that is poised to unleash its largest stimulus bundle since the pandemic to curb outgo of surviving and prop up the struggling Japanese economy, and the concerns astir Japan's ballooning indebtedness go adjacent much stark.

Magdalene Teo, caput of fixed income probe for Asia astatine Julius Baer, said that the caller indebtedness issuance of 11.7 trillion yen to concern Prime Minister Sanae Takaichi's supplementary fund is 1.7 times larger than that issued nether her predecessor Shigeru Ishiba successful 2024.

"This highlights the trouble the authorities faces successful balancing economical stimulus initiatives with maintaining fiscal sustainability," Teo said.

In August 2024, an unwinding of yen-funded leveraged transportation trades owed to a hawkish BOJ complaint hike and disappointing macro information from the U.S. saw stocks globally sell-off, with Japan's Nikkei crashing 12.4% to grounds its worst time since 1987.

Carry commercialized refers to borrowing successful a currency with little involvement rates and investing successful high-yielding assets, with the Japanese yen being the predominant currency backing specified trades arsenic the country's had a antagonistic involvement rates policy.

Now, rising Japanese yields person narrowed that complaint differential, fueling concerns astir different circular of transportation commercialized unwind and repatriation of funds into Japan. However, experts accidental that a repetition of the 2024 meltdown is unlikely.

"From a planetary perspective, the narrowing Japan–U.S. output spread reduces the entreaty of yen-funded transportation trades, but we bash not expect a repetition of the 2024 systemic unwind ... Instead, expect episodic volatility and selective deleveraging, peculiarly if yen spot accelerates backing costs," said Masahiko Loo, elder fixed income strategist astatine State Street Investment Management.

Loo attributes said structural flows driven by retail allocations from pensions funds, beingness insurance, and NISA [Nippon Individual Savings Account] anchor overseas holdings, making large-scale repatriation unlikely.

Justin Heng, APAC rates strategist astatine HSBC, concurred, saying that Japanese investors person shown small motion of repatriating funds, and person remained nett buyers of overseas bonds.

From January to October 2025, they purchased 11.7 trillion yen successful overseas debt, acold outpacing the 4.2 trillion yen bought successful each of 2024, according to HSBC. That surge has been driven chiefly by spot banks and plus managers benefiting from retail inflows nether the Japanese government's tax-exempt concern program.

"We expect the continued diminution successful hedging cost, arsenic a effect of further Fed complaint cuts, volition besides apt promote Japanese investors to instrumentality much overseas enslaved exposure," Heng said.