10-Year JGB Hits Near 30-Year High, 30-Year JGB Yield Breaks 4%. Will It Deal a Devastating Blow to US Treasuries?

TradingKey - During Asian trading on Monday (May 18), the 10-year Japanese Government Bond (JGB) yield rose to 2.8% at one point, reaching a nearly 29-and-a-half-year high since October 1996. Last Friday (May 15), the 30-year JGB yield broke 4% for the first time in history, and yields continued to hit new highs on Monday, peaking at 4.205%.

The Japanese bond market is experiencing a historic transformation, with the primary catalyst being the U.S.-Iran war. The conflict has caused oil prices to spike, intensifying Japan's imported inflation. Furthermore, the Sanae Takaichi administration's energy subsidy policies have heightened market anxiety regarding increased bond issuance, sparking a sell-off in sovereign debt.

However, a key factor to consider is that Japanese investors hold approximately $1 trillion in U.S. Treasuries. Could a collapse in the Japanese bond market trigger a contagion effect in the U.S. Treasury market?

Capital flows back into the Japanese bond market

Japan is by far the largest foreign creditor of the United States, which is closely linked to the ultra-low interest rate policy Japan has implemented for a long time. Because Japanese interest rates are so low, domestic bond purchases offer almost no return; consequently, Japanese institutional investors—such as insurance companies, pension funds, and banks—have ventured abroad to invest in global assets like U.S. and European bonds, with U.S. Treasuries being particularly favored.

However, as JGB yields rise significantly, this situation could reverse. Market data shows that the Japanese bond market has begun to see signs of capital repatriation, albeit on a small scale. According to data from fund monitoring agency EPFR, Japanese sovereign bond funds saw a net inflow of approximately $700 million in March this year, marking the largest single-month inflow on record for this category; in April, net inflows reached $86 million.

British asset management firm BlueBay launched its first Japanese bond fund just this past March. Chief Investment Officer Mark Dowding stated that new capital will no longer be allocated overseas—it won't flow into U.S. corporate bonds or U.S. Treasuries, but will instead be allocated domestically within Japan. Matt Smith, a fund manager at investment firm Ruffer, shares a similar view: as Japan's domestic long-end yields continue to rise, the signal at the institutional level is "please bring the money back to Japan."

Smith believes that yen appreciation will occur slowly at first and then accelerate suddenly. Currently, Ruffer holds long yen positions as a core hedging tool. Smith identified the catalyst for future yen strength: once market turmoil occurs—particularly volatility centered on the U.S. credit market—Japanese investors will bring their capital back home, at which point the yen will strengthen.

About to Lose Largest Foreign Creditor! Is a U.S. Treasury Crisis Looming?

Analysis suggests that as the largest creditor with holdings totaling $1 trillion, a move by Japanese institutional investors to reduce their positions would deal a severe blow to the supply-demand dynamics of U.S. Treasuries. Notably, beyond the external impact of potential Japanese selling, the U.S. government is currently grappling with a massive fiscal deficit, and the scale of debt issuance needed this year has expanded further. Consequently, U.S. Treasuries could face a shortfall in demand, forcing long-term Treasury yields to surge passively.

However, since the reduction by Japanese institutional investors is systemic, it will not cause a one-off shock to U.S. Treasuries; the gradual repatriation of funds still leaves ample reaction time for the market. Additionally, because U.S. Treasuries boast the deepest liquidity pool in global markets, the impact of Japanese selling will be significantly dampened by the time it transmits to U.S. debt.

Analysts point out that despite emerging signs of repatriation, Japanese investors remained net buyers of foreign debt over the past 12 months, totaling approximately $50 billion. This indicates that the point at which Japanese fund flows would severely disrupt the U.S. Treasury market has not yet arrived.

In light of expectations that JGB yields may continue to climb, Abbas Keshvani, Asia macro strategist at RBC Capital Markets, said: "As an investor, if you know yields are going to continue to go higher, it's very difficult to have an appetite to buy now." Analysts forecast that the 10-year JGB yield will reach 3% later this year.