Japan’s benchmark 10-year government bond yield climbed above 3% on Tuesday for the first time in three decades, as markets increased bets on further monetary tightening and investors demanded higher compensation for the country’s growing fiscal risks.
The yield rose 6 basis points to just above 3%, its highest level since 1996, adding to pressure on Tokyo as it prepares its next budget and grapples with the rising cost of servicing its enormous public debt.
The move came as U.S. Treasury Secretary Scott Bessent signaled that Washington expects Japan to take steps to support the yen, including potentially higher interest rates from the Bank of Japan.
Register for the next Tekedia Mini-MBA.
Register for Tekedia AI in Business Masterclass.
Join Tekedia Capital Syndicate and co-invest in great global startups.
“I have information that the market doesn’t have. And it’s my belief that the Japanese government and that the BOJ will do the things that will lead to a stronger yen,” Bessent told CNBC on Monday.
A U.S. official told Japanese broadcaster NHK that Bessent had emphasized the need for Tokyo to demonstrate a credible path toward fiscal sustainability and pursue further rate increases during separate meetings with Finance Minister Satsuki Katayama and BOJ Governor Kazuo Ueda.
Katayama said Japan and the United States had agreed to continue coordinating efforts to achieve “orderly” movements in the yen and remained prepared to respond to “disorderly” currency moves, according to Reuters.
The comments come as the yen weakens toward levels that could force Tokyo to consider another intervention. The currency was last trading around 160.1 per dollar, breaking above the psychologically important 160 level for a third consecutive session.
Japan and the United States conducted a rare coordinated intervention in late July to support the yen, but the currency has since surrendered much of those gains. A prolonged decline in the yen is becoming increasingly problematic for Tokyo because it raises the cost of imported energy, food and other goods, adding to inflationary pressure on Japanese households.
The bond market is now pricing a greater probability of a BOJ rate increase as early as September. Takuji Okubo, managing director at Japan Macro Advisors, said investors may also be reassessing where Japanese rates will ultimately settle in the current tightening cycle.
“Japan’s higher borrowing costs on Tuesday reflect a rising chance of a Bank of Japan rate hike in September, and the market perhaps adjusting the terminal rate from 1.5% to 1.75% or higher,” Okubo told CNBC.
The BOJ’s benchmark policy rate currently stands at 1%.
The surge in Japanese yields weighs beyond Japan because of the country’s position at the center of global capital markets. Japan is the largest foreign holder of U.S. government debt, meaning any decision by Tokyo to support the yen through foreign-exchange intervention could have implications for the U.S. Treasury market.
Japan typically acquires dollars when intervening to weaken the yen and can sell dollar-denominated assets, including U.S. Treasuries, when supporting its currency. A substantial liquidation of Treasuries could add to upward pressure on U.S. long-term yields at a time when global bond markets are already facing concerns over inflation, government borrowing and elevated debt issuance.
The latest increase in Japanese yields has also occurred against a deteriorating global inflation backdrop. The resumption of military hostilities between the United States and Iran over the weekend has revived concerns about energy supplies and inflation, putting additional pressure on government bonds around the world. Bond prices move inversely to yields.
For Japan, however, the rise in yields also marks another stage in the country’s departure from the ultra-low interest-rate environment that defined its economy for decades. A 3% 10-year borrowing cost would have been almost unthinkable during the years when Japan struggled with persistent deflation and negative interest rates.
Higher yields now indicate that investors increasingly expect Japan to operate in an environment of sustained inflation and positive real economic adjustments.
“A 3% 10-year borrowing cost is high in historical perspective, but it just means another step for Japan in leaving deflation in the past and joining the rest of the world where 2% inflation is an achievable normal,” Okubo said.
The challenge for policymakers is balancing those forces. Higher rates could support the yen and help contain imported inflation, but they would also increase borrowing costs for the government, households and companies. With Japan carrying one of the world’s highest public-debt burdens relative to economic output, even modest increases in interest rates can have significant fiscal consequences.
That tension is likely to keep Japanese bonds, the yen and BOJ policy closely watched by global investors. A further rise in Japanese yields could also encourage domestic investors to redirect capital away from overseas markets and toward Japanese assets, potentially affecting global bond and currency markets.
The combination of a weakening yen, rising bond yields and pressure from Washington leaves Tokyo’s policymakers with a difficult policy equation: support the currency without destabilizing financial markets, while tightening monetary policy without placing excessive strain on an already heavily indebted government.