Tokyo’s evolving monetary policy is sending ripples through global bond markets, and U.S. Treasuries are feeling the initial tremors. For decades, Japan has acted as a quiet stabilizer, but a shift in economic strategy is prompting a reassessment of its role and raising concerns about the potential for increased volatility in the world’s safest asset.
Japan remains the largest foreign holder of U.S. Treasuries, with roughly holdings exceeding $1 trillion, representing 12.4% of all foreign-held federal debt. This longstanding position has been underpinned by the yen carry trade – borrowing in yen and investing in higher-yielding U.S. Bonds. However, rising Japanese bond yields are now threatening to unwind this arrangement.
The change in direction began to take shape following the appointment of Sanae Takaichi as prime minister in . Her tax-cutting and spending plans triggered a sell-off in Japanese government bonds (JGBs). As of recently, the yield on the benchmark 10-year JGB stood around 2.12%, having retreated from earlier three-decade highs. Over the past year, the spread between the 10-year Japanese bond and the U.S. 10-year Treasury has narrowed by approximately 115 basis points, signaling a significant shift in relative yields.
The narrowing spread isn’t limited to the U.S. The gap between Japanese, and U.K. 10-year bonds has shrunk by around 92 basis points, and the difference between Japanese and German bonds has decreased by about 45 basis points. This suggests a broader recalibration of global bond market dynamics.
Analysts warn that investors may not be fully accounting for the potential consequences of rising Japanese yields. Nigel Green, CEO of wealth advisory deVere Group, cautioned that a “steady reweighting back into JGBs is likely to be enough to shift global pricing.” He anticipates a sustained rise in long-term bond risk premiums, a steeper yield curve, and tighter financial conditions worldwide if Japanese investors begin repatriating capital.
The implications extend beyond simple yield adjustments. Treasuries are central to global collateral markets, meaning disorderly moves could cascade through banks, hedge funds, and pension systems. The situation is further complicated by America’s own fiscal challenges, with chronic deficits and swelling debt limiting the Federal Reserve’s ability to absorb foreign selling without risking inflation.
Derek Halpenny, head of research in the global markets EMEA and international securities division of MUFG, believes it’s “complete sense” for Japanese investors to consider keeping more capital within their domestic bond market. He argues that factors beyond yield levels, such as increased confidence in Japan’s economic management under Takaichi, will play a crucial role. Takaichi has emphasized prudent fiscal policy, which has contributed to a recent cooling of JGB yields.
The Bank of Japan’s (BOJ) monetary policy is also under scrutiny. Halpenny suggests that two or three rate hikes are needed to restore investor confidence in the central bank. In , the BOJ ended its decade-long stimulus program and subsequently raised interest rates several times, holding its key rate steady at 0.75% in after raising it to its highest level since the 1990s the previous month. As rates increase and inflation subsides, conditions are improving for better JGB investor sentiment.
However, Halpenny anticipates a gradual shift, with new investments directed towards JGBs and existing investors gradually diversifying their portfolios. He notes that, as of the end of its fiscal third quarter, the Government Pension Investment Fund (GPIF) held 50% of its investments in the bond market, with nearly half of those holdings in foreign bonds, totaling 72.8 trillion Japanese yen (approximately $470.6 billion).
James Ringer, global unconstrained fixed income fund manager at Schroders, emphasizes that the potential return of Japanese capital is “a risk that needs constant monitoring.” He adds that JGB volatility remains relatively high and liquidity relatively low, suggesting that significant repatriation flows would require improvements in both areas.
Even if Japanese investors maintain their existing overseas holdings, the change in JGB yields could have a broader impact. Nigel Green points out that Japan’s historically ultra-low rates have anchored the lower bound of expectations for global yields. “Once the final holdout normalizes, the case for permanently suppressed yields weakens everywhere,” he said. Japan’s historical stability, stemming from domestic investors owning most government debt, is also being questioned. A more yield-sensitive and volatile JGB market could alter the tone of global fixed income.
The situation presents a complex challenge for the U.S. Japan’s Treasury stockpile has become a form of strategic leverage within the U.S.-Japan alliance, particularly as Washington’s fiscal discipline weakens. The risk is not merely financial; it’s a structural dilemma with potentially far-reaching consequences for global markets and the stability of the world’s financial system.
For investors, prudence dictates diversification, maintaining liquidity buffers, limiting duration exposure, and avoiding excessive leverage. The world’s safest asset is quietly becoming its most consequential pressure point, and navigating this evolving landscape will require careful consideration and a long-term perspective.
