Recently, Japan’s 30-year government bond yields ascended to a historic peak of 3.52%, a dramatic uptick amounting to a 48-basis-point rise from November last year. This sharp climb in long-dated bond yields has drawn attention towards possible ripple effects extending into U.S. and broader international financial markets.
For decades, Japan’s financial landscape has been characterized by ultra-low yields, including persistent negative short-term interest rates. However, over the past year, this low-yield environment has been disrupted by substantial increases in government borrowing costs. The catalyst for this shift is primarily attributed to growing unease regarding Japan’s fiscal sustainability, driven by the recent parliamentary approval of a record-breaking budget.
The fiscal year commencing April 2026 will implement a ¥122.3 trillion (approximately $785 billion) budget, representing significant escalations in social welfare and defense expenditures. This expanded fiscal commitment is compounded by an additional economic stimulus package totaling ¥21.3 trillion (roughly $140 billion), endorsed by the administration of newly appointed Prime Minister Sanae Takaichi.
Amid these fiscal expansions, economists like Robin Brooks have noted that although yields have risen markedly, they remain suppressed relative to levels that would be determined by entirely free market pricing. This suppression is largely due to the Bank of Japan’s role as a major purchaser of longer-term government bonds, effectively placing a ceiling on yields.
Brooks points out that the increasing threat of a government debt crisis is being reflected more in the value of the Japanese yen than in bond yield levels. The yen’s depreciation is evident, declining over 34% against the U.S. dollar during the last five years and 6.6% in the past six months alone, a period that witnessed considerable dollar weakness as well.
This currency depreciation underscores the importance of monitoring yen movements as an indicator of Japan’s fiscal risk, arguably even more closely than bond yields themselves.
The growth in yields and the weakening yen must also be understood within the context of Japan’s long-enduring low-interest-rate policy, which has supported one of the globe’s largest "carry trades." In this strategy, investors traditionally borrowed funds at low cost in yen and reinvested the proceeds into higher-yielding foreign assets. This carry trade experienced a significant reversal in 2024 after the Bank of Japan ended its negative short-term interest rate policy for the first time in 17 years, leading to a swift unwinding of positions established over nearly two decades.
The rapid dismantling of this carry trade triggered considerable market disruption, with hedge funds compelled to close their positions rapidly, resulting in diminished liquidity and increased volatility across international markets.
Currently, as Japanese bond yields continue to set new highs, market participants are preparing for potential headwinds. This caution was heightened by the Bank of Japan Governor Kazuo Ueda’s recent subtle indications of prospective rate hikes. Since then, asset classes such as U.S. equities, Bitcoin, and U.S. Treasury securities have experienced downward pressure.
Nevertheless, some experts remain skeptical about the prospect of a resurgence in yen carry trade risks. Bob Elliott, Chief Investment Officer at Unlimited, highlighted in his Substack newsletter that exposure to Japan’s monetary policy changes appears significantly reduced since the global financial crisis in 2008. His assessment finds support from Adarsh Sinha, global head of G10 Rates and FX strategy at BofA Securities, who pointed to currently absent signs of an excessive build-up in yen carry trade positions. This conclusion is partly based on data from yen-denominated bond issuances by foreign firms.