As the world focuses on fast-changing geopolitics, escalating trade spats and the war in Ukraine, another part of the bond market is brewing contagious fumes that may spill out and push borrowing costs higher.
Japan may finally be escaping from its deflationary spiral. The cradle of quantitative (and later qualitative) easing may even have to sharpen its inflation-fighting tools again.
Some may dismiss Japan and its financial influence after years of stagnant economic growth. But history shows that when Japan sneezes in its monetary handkerchief, economies elsewhere catch a cold.
Japan is a heavy exporter, and its biggest export is capital.
The carry trade of borrowing money cheaply in yen to finance investments in other currencies has propped up asset classes ranging from currencies to Mexican government bonds to US tech stocks.
So when that trade becomes less attractive, multiple markets get a kick.
The world got a taste of this correction at the end of July last year, after the Bank of Japan surprised the market with a 20bp rate rise, causing sharp falls in equity valuations.
The 10 year US Treasury yield climbed 4bp in a couple of days, in the dead quiet August lull.
Since then, Japanese government bond yields have been steadily climbing, above their August levels. While they are still far below those in other major bond markets, the proportional rise has been staggering, and alarming.
The 10 year JGB yield has jumped 30% since the beginning of the year and more than doubled in the past 12 months. It ended Thursday above 1.54%.
Compared that with the 10 year US Treasury. Despite generally rising sovereign yields in major economies this year, its yield has actually fallen nearly 7% since the beginning of 2025 and is less than 2% higher over the past year.
Even in Germany — where a plan for massive defence and infrastructure spending has barged rates wider across Europe — the 10 year Bund yield has barely changed over the past year, and is about 20% up since the start of 2025.
This matters because Japan commands a huge savings pool and, unlike many other Asian economies, has no capital controls. Its institutional investors are real money buyers, and often indulge in foreign assets.
But they are sensitive to the now shrinking yield differentials, while volatility is raising their costs for hedging back to yen. That could prompt them to repatriate money.
Japan warrants far more attention than it is getting, from all sorts of issuers, especially in the SSA world.
Inflation remains higher than desired. Wholesale prices rose 4% year-on-year in February. Though that was down from 4.2% in January, core CPI — which spiked to a 19 month high of 3.2% in January — has been above the Bank of Japan’s 2% threshold for almost three years.
The next BoJ monetary policy meeting, on March 19, should be closely followed for signs of when the central bank will raise rates next. That could pull Japanese capital back home, and maybe even foreign capital.
Tightening Japanese money will not be a breeze for the rest of the world. It will have liquidity-draining repercussions.