How Japan broke the world’s favorite free lunch

It’s always a bad sign when Japan makes headlines. That’s because the country used to sit quietly in the background for the majority of this century.

Rates were near zero, the central bank bought almost everything in sight, and investors treated the yen as a bottomless funding source.

And just like August 2024, the country broke character again and markets are rattled with Japan bond yields jumped to their highest levels since 2008.

They also pulled US Treasury yields back above 4%, hit European bonds, and most importantly, knocked equities and crypto at the same time.

Most investors are questioning whether Japan’s bond market is an indicator of things to come. Because they consider Japan as the world’s “cheap money machine”. And what happens when that machine malfunctions?

Why everyone suddenly cares about a 1.8% yield in Japan

Start with the facts. Japan’s 10-year government bond yield touched about 1.88% this week, the highest in roughly 17 years. The 2-year yield pushed above 1% for the first time since 2008, while the 30 year yield climbed to a record near 3.4%.

BloombergThat jump did not come out of nowhere.

Bank of Japan governor Kazuo Ueda has indicated clearly that the board will “weigh the pros and cons” of another rate hike at the 19 December meeting.

Markets now price a high probability that the policy rate, already lifted out of negative territory earlier this year, will rise again.

At the same time, the new government under Prime Minister Sanae Takaichi has approved an extra budget of about 18.3 trillion yen, funded largely by 11.7 trillion yen in new bonds. Japan’s public debt is already above 230% of GDP, the highest among major economies.

Put those pieces together, and you get a simple story.

The central bank is stepping away from its long experiment of capping yields. The government is leaning harder on the bond market to finance fresh stimulus.

So investors are demanding a higher return to hold that debt.

How Japan’s move punched up US Treasuries and everything else

The surprise for many investors was not that Japanese yields rose. It was how quickly the shock spread.

On the same day JGB yields spiked, the US 10-year Treasury yield jumped to around 4.08-4.09%, its highest level in about two weeks.

That move happened even as futures markets priced an almost 90% chance that the Federal Reserve will cut rates again this month.

BloombergEconomic data, from factory surveys to employment figures, have been soft rather than hot.

By textbook logic, that should have pulled long yields down, not up. But two things overrode the textbook.

First, supply. The week opened with a wave of corporate bond sales in the United States, led by an 8 billion dollar deal from Merck.

When companies rush to issue debt on the same day that governments also need financing, investors demand slightly higher yields to absorb it all.

Second, and more important, funding. For years, global investors borrowed in yen at tiny interest rates and bought higher-yielding assets abroad, from Treasuries to emerging market bonds to crypto.

The “yen carry trade” relied on one idea. Japan would keep rates pinned near zero while the rest of the world offered better returns.

Once Japanese 2-year and 10-year yields start looking more respectable, that math changes.

If an investor can earn close to 2% at home in a stable currency, the extra reward for owning a 4% US bond, with currency and political risk, looks smaller.

Some investors start to pay back their yen funding and reduce foreign holdings. Others think twice about buying the next US or European bond issue.

This change in sentiment does not require a full-scale stampede to move prices.

Japan is the world’s largest creditor nation with net overseas assets above $3.6 trillion. If a small slice of that is repatriated, or if new flows simply stay at home rather than going into Treasuries, global term premiums move higher.

You could see the stress across assets. German bund yields rose to around 2.75%.

Bitcoin dropped more than 5% on the day and is now roughly 30% below its October peak.

Meanwhile, precious metals continue their upwards momentum.

This time, investors are not rotating within risk assets, but actually de-levering and raising cash.

Bloomberg## Bond buyers are back, but on new terms

There is an important twist. The same markets that sold off hard on Ueda’s comments also showed that Japanese bonds still have buyers at these higher yields.

The latest 10-year JGB auction cleared with a bid to cover ratio near 3.6, above both the previous month and the recent average, and with a very tight pricing “tail”.

In simple terms, plenty of investors were happy to take down the bonds once the yield was close to 1.9%.

Japan’s Finance Ministry is also skewing new issuance towards shorter maturities, such as 2 and 5-year notes and treasury bills, while keeping long and super-long supply roughly steady.

That reduces the immediate risk of a failed long bond auction, yet it also spreads higher funding costs more quickly through the debt stock.

This gives a clear signal to global investors that the BoJ is no longer trying to sit on the entire curve.

Market pricing is allowed to move, even sharply, as long as auctions still clear and financial conditions do not spiral out of control.

Strategists now talk openly about 10-year JGB yields moving toward 2.5% over the next couple of years if the tightening cycle continues.

This is why the recent auction relief should not be mistaken for a return to the old world.

The anchor has shifted. Domestic real money accounts, like insurers and pensions, are starting to lock in yields that were unthinkable two years ago.

These buying caps the immediate panic, but it does so at a much higher level of rates.

What it all means for global portfolios from here

For a global investor, this surge in Japan bond yields carries three practical lessons.

First, the reference point for “risk-free” yield is changing. For years, the hierarchy was simple. China at the top, then the United States, then Europe, with Japan stuck near zero at the bottom.

Today Chinese 10 year yields are below Japan’s, and US yields are the highest among major economies.

That mix-up tells you something about where growth and inflation are expected, but it also tells you who has to work harder to fund their debt.

Second, carry trades are no longer a “cash printing machine”. When Japan was pinned at zero, hardly anyone outside FX desks talked about yen funding.

Now the unwinding, or even the fear of unwinding, shows up in everything from tech stocks to digital assets.

Official data already show speculators transitioning from heavy short yen positions last year to record net longs this year as they bet on further hikes.

That change in positioning makes sharp moves in the currency and in global bond markets more likely, not less.

Third, policy choices in Tokyo now show up directly in the price of diversified portfolios.

A government that is adding to an already very high debt load through an 18 trillion yen stimulus, while its central bank slowly tightens and tapers bond buying, is inviting investors to reassess the compensation they require.

That reassessment does not stay inside Japan.

It spills back into the US yield curve, European credit spreads, and the valuation of anything that benefited from years of free yen funding.

The headline number on the chart, 1.88% on a Japanese 10-year bond, looks small next to a 4% US Treasury.

But the story behind it is not small. It is the story of a major economy stepping away from three decades of ultra-easy money, just as the rest of the world is trying to cut rates again.

That clash of directions is what investors are feeling in their bond holdings and in every asset that depended, quietly, on the kindness of the Japanese yield anchor.

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