Japan's long-term interest rates surged to 2.945% on August 18, reaching a nearly 30-year high. The increase is attributed to heightened expectations of a rate hike by the Bank of Japan (BOJ) in September, coupled with concerns over expanded government bond supply due to active fiscal policies. Market analysts predict that breaching the 3% mark for 10-year bonds is imminent.
On August 17, the benchmark 10-year government bond yield in the Tokyo bond market rose to 2.930%, the highest level since September 1996. The upward trend continued on August 18, peaking at 2.945%. The 2-year yield also climbed to 1.700%, the highest since May 1995, while the 5-year yield reached an all-time high of 2.180%.
The primary driver behind the rising rates is the expectation of an early rate hike by the BOJ. Last month, Japan and the U.S. jointly intervened to curb the yen's depreciation, and U.S. Treasury Secretary Scott Vessenes expressed confidence in BOJ Governor Kazuo Ueda's commitment to addressing the situation. However, the yen's weakness has not fully stabilized, leading to increased speculation that the BOJ will need to respond with a rate hike.
Market sentiment now views a September rate increase as a likely scenario. According to a survey by the short-term financial market research firm Dotan Research, as of the afternoon of August 17, the probability of the BOJ raising rates at its monetary policy meeting on September 17-18 has risen to approximately 80%. The overnight index swap (OIS) market also reflects an 80% likelihood of a rate hike.
If this forecast holds true, the BOJ would raise rates for the second time in three months, following an increase in June. This suggests that the previously typical six-month interval between rate hikes may shorten.
Internally, the BOJ is also sensing this shift. During last month's monetary policy meeting, some policymakers indicated that if inflationary pressures exceed expectations, the pace of rate hikes could accelerate.
Market focus is now shifting from whether a September hike will occur to how high the final policy rate will rise. Bank of America Securities predicts that the BOJ will implement four additional rate hikes by July 2027, raising the policy rate to 2%, an upward revision from the previous forecast of 1.75% by the end of 2027.
Additionally, the Japanese government's active fiscal policy is contributing to rising bond yields. As the government plans to increase spending, the likelihood of expanding bond issuance grows, which could lead investors to demand higher yields. The Takaiichi administration has committed to 'responsible active fiscal policy' and plans to eliminate budget caps for economic growth and crisis response in the 2027 budget proposal. Noriyasu Mizuho, chief bond strategist at Mizuho Securities, stated in the Nikkei that there is a strong possibility that market expectations for rising rates will spread ahead of next year's budget formulation.
There is currently little buying pressure to counteract the rising rates. Many analysts believe that significant demand for government bonds is unlikely in the near term. Recent auctions for 30-year and 10-year bonds saw weak investor demand. On this day, the Ministry of Finance set the coupon rate for the 5-year bond auction at 2.200%, the highest level since the bond's issuance began in 2000. Analysts suggest that uncertainty surrounding the BOJ's rate hike pace and final target may contribute to subdued auction demand.
The global rise in long-term interest rates is also exerting selling pressure on Japanese government bonds. In the U.S., concerns over fiscal deterioration and increased funding needs for AI data center investments have driven long-term Treasury yields higher. On August 17, the yield on U.S. 30-year bonds surpassed 5.31%, reaching its highest level since 2007.
These factors have led to predictions that breaching the 3% threshold for Japan's 10-year bonds is only a matter of time. Takafumi Yamawaki, a bond analyst at JPMorgan Securities, noted that unless there are changes in monetary policy or the yen's weakness, reaching 3% could trigger additional selling pressure, suggesting that 3% may not be the peak but rather the start of a new upward trend.
The rise in Japanese interest rates could also impact the U.S. Treasury market. Japanese institutional investors, who have sought higher yields abroad in a low-rate environment, may find U.S. Treasuries less attractive as Japanese yields rise, especially when considering currency hedging costs.
It remains uncertain whether a significant repatriation of Japanese capital will occur. However, as Japan is the largest foreign holder of U.S. Treasuries, reducing new purchases or reallocating maturing funds back to Japan could exert pressure on the U.S. Treasury market.
* This article has been translated by AI.
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