A global unwind of government bonds that gathered momentum about two weeks ago has eased in the last few days, yet traders largely remain cautious toward sovereign debt. Market participants are pricing in a higher probability of interest rate increases by central banks worldwide as authorities grapple with an inflationary impulse tied to a sharp rise in oil prices. Within that broader sell-off, movements in Japan’s fixed-income and currency markets have drawn particular scrutiny.
Japan’s 10-year government bond yield recently climbed to levels not seen since September 1996, while the 30-year yield surged to its highest reading on record. Investors have been selling government bonds as inflationary pressures mount, in part because Japan depends heavily on oil shipped through the Strait of Hormuz, and because market participants expect the Bank of Japan (BoJ) to begin raising policy rates.
The government has implemented measures to limit fuel costs by capping gas prices and providing aggressive subsidies to oil wholesalers. Those steps appear to have helped contain consumer inflation; core annual inflation in April slowed to a four-year low. At the same time, price dynamics at earlier stages of the economy are showing strength: producer prices increased last month at the fastest annual rate since May 2023.
Japan’s currency has also come under pressure. Many traders believe Tokyo engaged in currency intervention at the end of April, yet the yen has weakened again and moved back toward the psychologically important 160 per dollar level.
Thomas Mathews, head of markets Asia Pacific at Capital Economics, highlighted the interplay between currency moves and bond markets in a research note on Thursday. He said: "While FX intervention dominated the headlines a couple of weeks ago, Japan’s bond markets have come under increasing pressure. This Update argues that most of the past rise in yields has been benign, but that the market is approaching a point - if it’s not already there - at which the 'reflation trade' is fully priced in. Further rises in inflation and yields, therefore, might put greater pressure on the BoJ to act, either through rate hikes or its balance sheet."
Mathews added that although the increase in Japanese yields since the onset of the war has not been the largest among major economies - noting larger rises in the UK and similar moves in the U.S. and France - the shape of Japan’s yield curve stands out. He described a distinct 'bear steepening' of the Japanese government bond curve and said that this has attracted attention from policymakers, including at recent G7 meetings, where BoJ Governor Ueda remarked that the Bank was monitoring the market closely.
Beyond shorter-term market dynamics, Mathews pointed to Japan’s fiscal position as a key, longer-running driver of yields. He observed that the government’s decision to cap energy prices has exacerbated fiscal concerns. Using a scenario in which oil averaged about $130 per barrel over the rest of the year, Mathews estimated that the policy would cost the government roughly 2% of GDP. He said that such fiscal pressure increases the risk of considerably more debt issuance, consistent with comments from Prime Minister Takaichi about a possible supplementary budget. That, in turn, helps explain why long-dated yields have risen and why yields at the very long end have jumped even more, partially reversing their relative decline since mid-2025.
Investors tracking Japanese exposure through exchange-traded funds can look to instruments that follow the country’s equity markets, including the iShares MSCI Japan ETF, the JPMorgan BetaBuilders Japan ETF, and the WisdomTree Japan Hedged Equity Fund.
Market takeaway - The combination of oil-driven inflationary pressure, measures to cap domestic energy prices, perceived currency intervention, and concern about fiscal costs has placed Japanese government bonds and the yen under renewed pressure. That dynamic has raised the likelihood that the BoJ will need to respond either via rate increases or adjustments to its balance-sheet operations if inflation and yields continue to climb.
What remains uncertain - Whether further increases in inflation and yields will force concrete policy steps by the BoJ; the scale and timing of any additional bond issuance tied to energy subsidies or supplementary budgeting; and the extent to which currency intervention measures can influence the yen on a sustainable basis.