BOJ sees limits tested as long-term government bonds hit multi-decade highs

Yields on Japan’s long-term bonds just ripped through levels not seen in decades as markets pushed back hard against the Bank of Japan’s slow exit from ultra-loose policy.

As of Wednesday, the 30-year bond yield reached 3.286%, its highest point in over twenty years. The 20-year yield hit 2.695%, a level last seen in 1999.

The 10-year benchmark bond is sitting at 1.633%, marking its highest level since 2008, while the 40-year yield rose to 3.506%, almost 90 basis points up since January.

What’s driving this brutal surge? The Bank of Japan is trying to cool things down. But three years of consumer prices staying above the 2% inflation target have made that job nearly impossible.

The central bank has started to raise short-term policy rates and cut back its bond-buying, but it’s not working fast enough. The real policy rate in Japan is still buried at -2.6%, meaning inflation-adjusted interest rates remain far below zero.

Foreign investors unload bonds while BOJ tries to maintain stability

Foreign demand for Japanese bonds is falling fast. Japan Securities Dealers Association data showed that total foreign bond purchases dropped 6% in July, down to 7.66 trillion yen compared to April.

Many overseas investors are backing away from bonds and pouring into Japanese equities instead, chasing big gains in the stock market. The appeal of long-term bonds is weakening fast, especially when inflation is still hanging around and the BOJ hasn’t made its next big move clear.

At the same time, domestic politics is adding more noise. Prime Minister Shigeru Ishiba’s coalition got slapped in the July upper-house elections, as opposition parties calling for consumption tax cuts made gains.

Ishiba, speaking Tuesday, told reporters he has “no intention at all of clinging” to his position. If he steps down, Japan could face multi-party gridlock and more pressure to boost spending, which will keep bond yields climbing.

Barclays analysts say the 30-year bond market is already pricing in tax cuts worth 1-2 percentage points, and warned that if deeper cuts are pushed through, the pressure on yields could grow worse.

Capital starts flowing back home but full repatriation not expected

Some domestic investors are returning. David Roberts, head of fixed income at Nedgroup Investments, said his firm has already pulled money from the U.S. and the UK and bought Japanese bonds, for the first time in decades.

“This is the first time since I started managing funds in the 1990s I have bought Japanese bonds,” Roberts told CNBC.

But the enthusiasm is selective. Rong Ren Goh, fixed income portfolio manager at Eastspring Investments, said most investors are still focusing on shorter-duration bonds, while staying cautious on long-term ones. “Investors [will be] in no major hurry to aggressively leg into duration even as valuations appear more compelling,” he said.

Barclays’ Kadota pointed out that inflows back into Japan won’t be serious until the BOJ ends its rate-hiking cycle. Right now, the central bank is still in tightening mode, so buyers are waiting it out.

Banks still have plenty of yen parked at the BOJ that they could use to buy bonds before even thinking of dumping U.S. assets.

Meanwhile, Japan’s government is asking for more money. A lot more. Budget requests for the fiscal year starting April 2026 have hit a record ¥122.4 trillion ($822 billion). That’s up from ¥117.6 trillion the previous year.

The Defense Ministry alone wants ¥8.8 trillion, as the country tries to raise military spending to 2% of GDP by 2027. On top of that, ¥32.4 trillion is now needed just to finance existing debt, the highest ever recorded. That’s what rising yields do, they make it way more expensive to keep the system running.

As usual, the Finance Ministry will trim the numbers before finalizing the budget. Last year, they cut the initial ¥117.6 trillion request down to ¥115.2 trillion. But with interest payments climbing, political noise increasing, and investors ditching long-dated bonds, the pressure is already baked into the system.

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