Japanese Bond Yields Surge – What It Means For Markets?

Japanese Bond Yields Surge – What It Means For Markets?

For 30 years, betting against Japanese bonds was a career destroying trade. Tokyo piled up debt at 260% of GDP, kept rates at zero, and lent trillions to the rest of the world. Yet somehow, they got away with it, leaving doomsayers to go bust, waiting for a crisis that never came. But recently, something changed. Bond yields just hit their highest level since 2008. The yen is in freef fall and the new prime minister’s response was to issue another $135 billion in debt into a market that’s already choking on it. So when the world’s largest lender starts bleeding, what happens to the borrowers? My name is Guy and you’re watching Coin Bureau Finance. Before we get into it though, nothing in this video is financial advice. It’s just our take on whether Japan’s bond market is about to become everyone’s problem. If you find our videos useful, then smash that like button and let’s find out. So, who is this new prime minister and why is she picking a fight with the bond market? Well, Sai Takichi took office in October after winning a narrow leadership contest within Japan’s ruling party. She’s an ideological firebrand, a fiscal hawk turned big spender who’s positioned herself as the heir to Arbonomics, the economic program launched by the late PM Shinszo Abe. The difference is that Abbe at least pretended to care about fiscal consolidation eventually. Takayichi has dispensed with the pretense. In November, her cabinet approved a 21.3 trillion yen or $135 billion stimulus package. The stated goals are familiar. Subsidies for households struggling with energy costs, cash payments for families with children, strategic investments in AI, semiconductors, and defense. The funding mechanism is also familiar, Japanese government bonds or JGBs. And when asked how she’d cover shortfalls, Takahuchichi was refreshingly blunt. Additional bond issuance would fill the gap. This landed into a bond market that was already nervous. Japan’s debt to GDP ratio now sits at around 240%, the highest among wealthy countries. Now, some will complain that it’s not that bad if you subtract public assets and look at the net debt to GDP ratio instead. And they’re right. Japan’s net debt to GDP ratio is more like 140%. That certainly sounds better than 240%, but it will be little comfort in a country where interest payments already consume around a quarter of the government’s annual budget. And that’s with yields that until recently were pinned near zero. However you slice it, Japan is one of the most indebted countries on Earth. The Ministry of Finance, traditionally the guardian of fiscal discipline in Tokyo, has been effectively sidelined. Takayichi leads a minority government, which means she needs to keep coalition partners happy with spending. Austerity isn’t on the menu. However, the bond market was not impressed with Takahuchi’s new spending plans and responded by catapulting the 10-year Japanese government bond yield above 1.83%, 83%, the highest level since 2008. The 40-year yield recorded a new all-time high above 3.7%. Now, these might sound like small numbers when compared to US or UK borrowing costs, but for Japan, they represent a regime change. For three decades, Tokyo could borrow essentially for free. That era, though, appears to be ending, and the government is responding by borrowing more. This is what economists call fiscal dominance. When government spending overwhelms monetary policy, effectively forcing the central bank to keep rates low regardless of inflation or currency pressures. The textbook version ends with the central bank monetizing debt and inflation spiraling. Japan isn’t there just yet. But now, Japanese bond vigilantes, long feared extinct after decades of betting against Tokyo and losing badly, are starting to show signs of life. The problem is that Takayichi isn’t operating in a vacuum. Her stimulus collides directly with a central bank that’s trying very carefully to normalize policy after 17 years of negative rates. And the Bank of Japan is discovering that very carefully might not be careful enough. Now, the Bank of Japan is supposed to be independent. In practice, however, it’s trapped between a government that wants to borrow cheaply and a currency that’s in freefall, and it can’t satisfy both. Governor Kazuo UEA has been trying to thread an impossible needle. Since taking over in April 2023, he’s edge rates up from negative0.1% to positive0.5%, the highest since 2008. That sounds like progress until you check the inflation data. Japan’s CPI is running at 3%, which means real interest rates are still deeply negative, around minus2.5%. Savers are losing purchasing power. The yen keeps sliding. And yet, UEA held rates steady at the October meeting, citing quote high uncertainties. Normally, when a country’s bond yields rise, its currency strengthens because higher returns attract foreign capital. But Japan is doing the opposite. Yields are spiking and the yen is falling simultaneously, trading around 157 to 158 to the dollar. When both move against you at once, that looks like the market pricing in credit risk or at least fiscal incoherence. Finance Minister Satsuki Katayama recently said that intervention remains an option. Tokyo buying yen to prop up the currency. They tried that in 2024, spending an estimated 60 to 70 billion in suspected yen interventions. It worked for about 5 months and then the yen weakened again almost immediately because intervention treats the symptom not the cause. The cause is a 400 basis point gap between Japanese and US rates that makes the carry trade borrowing yen to buy higher yielding assets elsewhere irresistible. Each BOJ rate hike barely dents that differential. Moving from 0.5% to 0.75% doesn’t change much when US rates sit above 4%. Now, UEA has acknowledged the problem publicly, telling Parliament that the weak yen pushes up import prices, which feeds inflation, which should demand higher rates, which would blow up the government’s debt servicing costs. It’s circular. There’s no clean exit. And if UEA moves too fast, he risks triggering the exact chaos that paralyzed the BOJ 15 months ago. Because we’ve already seen what happens when Tokyo tries to normalize policy. In August 2024, they hiked rates by a quarter point and almost nuked the global financial system. And by the way, if you’re sick of getting caught off guard by macro market shocks like that one, why not position yourself ahead of the curve by signing up for our weekly newsletter? And while you’re at it, you can take advantage of the finance related deals we have for our loyal viewers. Simply click the link in the description below or scan this QR code and it’ll take you to our deals and signup page. The newsletter is absolutely free and the deals we have are exclusively for viewers of this channel. These include numerous bonuses, discounts, and promotions, so check them out. And now back to the video. It was supposed to be a routine rate adjustment. On the 31st of July last year, the Bank of Japan raised rates to 0.25% and announced plans to taper bond purchases. Hawkeish by Japanese standards, but hardly aggressive. Within a week, however, global markets had descended into a bloodbath. The nicay dropped 12.4% on the 5th of August in the worst single day crash since Black Monday in 1987. The yen rallied nearly 8% in four trading sessions. The VIX, Wall Street’s fear gauge, spiked above 60. The S&P 500 fell 3%. Bitcoin and Ethereum dropped 20% in hours. All because Tokyo nudged rates slightly less negative and hinted at reducing bond purchases. The mechanism was the carry trade. For years, hedge funds and institutional investors had been borrowing yen at near zero rates and plowing the proceeds into higher yielding assets. US tech stocks, emerging market bonds, crypto, anything that paid more than Japan’s nothing. The trade was so crowded and so leveraged that when the yen strengthened unexpectedly, margin calls cascaded across asset classes. Positions that had nothing to do with Japan got liquidated because the funding currency moved. The Bank of Japan duly blinked. Deputy Governor Ushida came out days later and promised no further hikes, quote, during periods of market volatility, effectively telling the market that the BOJ would back off whenever things got rocky. In other words, the central bank had handcuffed itself. Now, many have since predicted that the unwinding of the leverage represented by the yen carry trade was far from over and that a repeat event was not unlikely. Just as you can’t cure the flu by blowing your nose, you can’t kill the yen carry trade with a single leverage flush. It’ll take a lot more than a.25% rate hike to do that. Estimates suggest only 50 to 75% of speculative carry trade positions actually closed out during the aforementioned crash. The rest held on through the volatility and by late 2024, the trade was already rebuilding. CFTC data shows speculative yen shorts persisting well into 2025. Goldman Sachs and Namora have both flagged a second carry trade unwind as a major risk for 2026. So the BOJ remains trapped. They found out last year what happens if they hike too suddenly, but they also know what happens if they stay too loose. The yen keeps falling. Imported inflation keeps rising. And the bond market loses patience with Tokyo’s fiscal incontinence. So more than a year later, nothing has been resolved. The underlying fragility hasn’t gone away. It’s just waiting for the next trigger. But guess what? The carry trade isn’t even the biggest risk here. That’s fast money. Hedge funds moving in and out of positions in a matter of days. But there’s slower money moving, too. And it dwarfs the carry trade in scale. You see, Japan isn’t just a country with a debt problem. It also happens to be the world’s largest creditor nation, holding $3.7 trillion in net foreign assets. That includes roughly $1.1 trillion in US treasuries alone. For decades, this money flowed outward because Japanese investors had no reason to keep it at home. Domestic bonds paid nothing. If you were a Japanese life insurer with decades of obligations to meet, you bought US treasuries, European sovereigns, Australian corporate bonds, anything that offered actual yield. But with Japanese 30-year bonds now yielding 3.4%, the situation today is quite different. Hedged US Treasury yields after you pay to protect against currency swings are now below 1%. Suddenly, Japanese institutional investors can earn more at home in their own currency without hedging costs or foreign exchange risk. And they’re starting to act on it. Two of Japan’s biggest life insurers, Daichi Life and Nippon Life, have both publicly stated they’re reducing foreign bond holdings to buy domestic. Likewise, Fukoku Mutual Life has announced plans to reduce foreign debt holding and aggressively accumulate super long 30 and 40year JGBs. This strategy is not only for the very biggest institutions, though. Midsized insurers Tao Life and Daido Life have also shed holdings of hedged foreign debt recently, citing returns that no longer stack up against domestic options. So, why should you care? Well, allow me to walk you through the doom loop. Japanese insurers sell US treasuries to buy JGBs. That pushes US yields higher and removes a source of demand that’s been reliable for decades. Higher US yields strengthen the dollar against the yen. A weaker yen forces the BOJ to consider tightening further. BOJ tightening pushes JGB yields even higher. Higher JGB yields make domestic bonds even more attractive relative to foreign ones. Rinse and repeat. Each step reinforces the next, causing repatriation to snowball. And bear in mind, this is very different from the yen carry trade. Last summer, we saw hedge funds unwinding leverage positions in a matter of days. Violent, fast, and ultimately containable. But institutional repatriation is a slow grind. Life insurers don’t dump portfolios overnight. They adjust allocations over quarters and years. There’s no circuit breaker, just a steady drain on global liquidity as the world’s largest creditor nation gradually pulls its capital home. Now, we can see four ways out of this, and none of them are painless. The first is for the central bank to limp along, continuing to hike gradually and maybe reaching 1 to 1.5% by 2026. The yen stabilizes somewhere around 150, while the carry trade unwinds slowly rather than explosively. Inflation moderates and bond yields settle at levels that are uncomfortable but not catastrophic. This is the base case and most analysts assign it somewhere around a 60% probability. The problem with base cases though is they require nothing to go wrong. No external shocks, no political crises, no bond market drama. Japan has managed to limp along for 30 years, so maybe they can keep limping, but the margin for error has narrowed considerably. The second path is genuine reform. Takayichi’s wise spending somehow boosts productivity, leading to increased tax revenues. A future government ultimately implements fiscal consolidation, raising taxes and restructuring social security to bring the debt trajectory under control. This is what the IMF wants, having explicitly called for Japan to quote rebuild fiscal buffers. But they won’t be able to force this agenda down Japan’s throat the same way they did to Greece in 2015. Reform is politically implausible. Takayichi leads a minority government with no mandate for austerity. Her coalition partners are actually demanding more tax cuts, not hikes. The Japanese public, meanwhile, has been promised decades of benefits that the current fiscal path can’t deliver. Meaningful reform would require either a crisis large enough to force action or a political transformation for which there is little appetite. Let’s call it a 15 to 20% probability and that might be generous. Now the third path is a messy adjustment. The yen crashes towards 170 or beyond. JGB yields spike past what the government can sustainably service. The carry trade unwinds violently as it did in August 2024. Except this time the BOJ can’t credibly promise to back off. Global contagion follows in US equities, emerging markets, crypto, anything funded by cheap yen liquidity. It’s a gray swan scenario. Unlikely, but not unforeseeable, and there are no safety valves this time. We’ll call this around 50 to 20% probability as well, but the consequences are grave enough that even a small chance is worth contemplating. The fourth path is financial repression. The BOJ caps yields below inflation through continued bond purchases, accepting yen weakness as the cost. Negative real rates slowly erode this debt pile over decades in the same strategy the US and UK used after World War II to work down war debts. There’s no acute crisis, just a slow transfer of wealth from savers to the government. Retirees watch their purchasing power decay while the young inherit a cleaned up balance sheet. Nobody votes for it. Nobody announces it. It just happens by default. Now, by our estimation, these are the most likely outcomes. Notice that three of them have significant spillover effects well beyond Japan because when Japan adjusts, capital flows everywhere adjust with it. For the last three decades, Japan was the anchor of low global rates. Japanese capital flowed outward, suppressing yields wherever it landed. US treasuries, European sovereigns, Australian bonds, wherever. But that anchor is now dragging. The direct transmission channel is the US Treasury market. Japan is the largest foreign holder of American government debt with over a trillion dollars in exposure. The Treasury market has grown accustomed to reliable Japanese demand at every auction, but that reliability is gone. If Japan steps back, US yields rise to attract new buyers, not because of the Fed, but simply because a major customer has left the building. The US is running a $2 trillion annual deficit and needs to find buyers for that debt. If its most dependable buyer says Sananara and starts buying domestic bonds instead, someone else has to fill the gap. This comes at the cost of higher yields which tighten financial conditions. There is a second more fragile channel too, the banking system. Japan’s big three mega banks, Mitsubishi UFJ, Sumitomo Mitsui, and Mizuo are whales of global credit. Specifically, they are massive buyers of collateralized loan obligations or CLOS’s, the packages of debt that fund thousands of US and European companies. The danger here is the dollar funding gap. These banks often borrow dollars short-term to buy these long-term foreign assets. But when the yen creates volatility or US short-term rates stay high, the cost of this funding explodes, turning profitable trades into massive losses. We’ve already seen the first casualty. Norin Chukin Bank, Japan’s agricultural giant, was forced to liquidate $63 billion in foreign bonds and CLOS this year because they got caught on the wrong side of this interest rate shift. If the big three mega banks face similar pressure to repatriate capital to cover domestic losses, they’ll pull liquidity from the plumbing of the global financial system. This means less funding for US corporations and tighter credit conditions worldwide. It’s a recipe for a liquidity shock that transmits instantly across borders. And finally, we have the yen itself as a transmission channel. The yen functions as the world’s funding currency, the cheap source of cash for carry trades that reach into every asset class. Currency appreciation forces a margin call on everything bought with borrowed yen. as we saw with the massive liquidation event of August 2024. Now, there are quite a lot of different threads to follow here, but if you want to stay on top of all of this, there are three key indicators we suggest watching. First, the 30-year JGB yield. If it pushes sustainably above 3.5%, the bond vigilantes have won and fiscal sustainability questions become acute. second USD JPY. If it breaks 160, we’re back in yen intervention territory. And if the BOJ steps in and fails to hold the line, confidence collapses. Third, and most importantly, the triple weakness. Watch for days when the nicay drops, JGBs drop, meaning yields rise, and the yen drop simultaneously. This is what capital flight looks like. It means foreign investors are fleeing Japan entirely because they fear fiscal dominance. This is the nightmare scenario for the Bank of Japan because it forces them to hike rates aggressively to defend the currency. And that forced hike is what triggers another massive unwind of the global carry trade. For decades, Tokyo racked up debt levels that would have sunk any other developed economy, froze interest rates while the rest of the world normalized, and printed the yen into oblivion without ever triggering a crisis. But the conditions that allowed Japan to defy gravity for so long are eroding simultaneously. The fiscal anchor is gone as Takayichi has made clear that stimulus comes first and consolidation can wait. The monetary anchor is gone as yield curve control was abandoned and rates are rising for the first time in a generation. What remains is market discipline and markets are starting to impose it. The carry trade hasn’t gone anywhere. The repatriation trade is just setting in motion and the government is responding to bond market stress by issuing more bonds. So keep your eyes peeled on those yields because like I said, when Japan moves, everything moves. And in the meantime, you can learn more about another island nation economy that’s struggling by checking out our video on the UK’s problems right over here. That’s all from me for now, though. As always, thank you for watching, and I’ll see you next time. This is Guy. Over and out.

Japan’s bond market is in revolt. Yields just hit their highest since 2008, the yen is in freefall, and the new Prime Minister’s response was to borrow another $135 billion. It’s the world’s largest creditor nation – but what happens when Japan needs its money back?

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The information contained herein is for informational purposes only. Nothing herein shall be construed to be financial legal or tax advice. The content of this video is solely the opinions of the speaker who is not a licensed financial advisor or registered investment advisor. Trading stocks poses considerable risk of loss. The speaker does not guarantee any particular outcome.

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