The moves were triggered by a loss in confidence stemming from Prime Minister Sanae Takaichi's fiscal stimulus plans - with some calling it her 'Liz Truss' moment - combined with expectations of further interest rate normalisation following decades of near-zero.
Japanese government bonds (JGBs) have sold off dramatically in recent days and the growing expectation is for some Bank of Japan, or even the US Federal Reserve, intervention to temper yields.
Yields on the Japanese 10-Year have hit over 2.2% as a result of the sell-off, having been steady in the 1% area or below for many years. At the time of reporting, they had closed trading at 2.288%, according to data from MarketWatch.
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At the longer-end, yields have been even more volatile, with the 30-Year above 3.6% and the 40-Year hitting record levels above 4%.
The moves were triggered by a loss in confidence stemming from Prime Minister Sanae Takaichi's fiscal stimulus plans - with some calling it her 'Liz Truss' moment - combined with expectations of further interest rate normalisation following decades of near-zero.
Having taken up the post last October, Takaichi's government has laid out plans to boost the economy through government spending and tax cuts, all with the view of winning the snap election she called earlier this month.
But with the ability to properly fund this spending conspicuous by its absence and rates potentially having to go up, investors are far from convinced.
The sliding yen of the past six months and recent spike in bond yields is not only a problem for Japan; it has caught the attention of US Treasury Secretary Scott Bessent.
The concern, from his perspective, is that a low Japanese yen will make its exports significantly more competitive and work against the Trump administration's well-documented agenda of rebalancing trade between the US and other regions.
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The turmoil in the Japanese bond market has also raised the risk of the dreaded ‘contagion', where loss of confidence in one part of the market bleeds into others. This could be exacerbated by Japan selling off US Treasuries to raise cash to support its own bonds and currency.
The US dollar has been under pressure for months, and the prospect of a knock-on effect to US Treasuries is not a palatable one for investors.
This has lead to expectations the Federal Reserve will intervene in the Japanese bond market, in a pincer move with the BoJ. The exact nature of that intervention is very unclear. In theory, the Fed could join the BoJ in becoming the ‘buyers of last resort' for JGBs.
The move in bond yields has caught many investors offside and left banking on intervention to rescue their positions rather than selling after the horse has bolted, although some will be feeling vindicated in their aversion to the asset class.
David Roberts, head of fixed income at Nedgroup Investments, said: "Understandable carnage in the JGB market. The Bank of Japan was far, far too slow to address persistent inflation last year. We were zero weighted JGBs for nearly 18 months until the price collapsed late last year and have added since."
"However, we are less than 50% index weight and although we might add some – there is every chance the BoJ intervenes – the damage they have inflicted on long-dated bonds globally means we can just buy US, UK or Germany to play any bounce," he added.
"Donald Trump beware – that multi-trillion-dollar US deficit relies on bond investor largesse just as much as Japan does."
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Roberts added that Takaichi seems to be taking a lead from Trump's play book, which he described as "fiscal stimulus and to hell with the consequences".
"The sell off in long JGBs threatens higher yields globally, hellish news for Trump trying to force mortgage rates down and again buy votes," he continued. "A US president with sub 40% approval when equities are at record levels and growth is decent? I think that is unparalleled."
Colin Finlayson, investment manager at Aegon Asset Management, said: "JGB yields have been rising in response to the prospect of further rate hikes from the Bank of Japan and this was accelerated after Takaichi's surprise victory last year to become the leader of the ruling LDP party.
"Her pro-growth stance, and willingness to use fiscal spending to achieve this, has spooked the JGB market and has seen 40-Year yields hit their highest level since 2007," he continued. This election, he argued, could increase her grip on power and the chances of her mandate being delivered.
Finlayson noted JGBs had already looked unattractive, and recent events have done nothing to change that. Much of the pain has been felt by long-dated bonds, he noted, which have "little or no natural demand", leaving it difficult to see what supports prices in the near term.
"Any investors buying them today simply on a valuations basis alone should be braced for further underperformance," he continued. "Some form of circuit-breaker in the form of official intervention in the JGB may well be needed to stop rot."
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Getting an agreement on central bank intervention over the line is not likely to be straightforward.
Naomi Fink, chief global strategist at Amova Asset Management, said the Japanese economy and BoJ policymakers are stuck between competing priorities.
She highlighted that there are elements within the BoJ's recent statements signalling the Bank has some ways to go before reaching ‘neutral' policy. One such indicator is the dissent of known hawk Hajime Takata, nodding to the internal pressure the BoJ faces to continue withdrawing stimulus over time.
"Importantly, the BoJ now flags yen weakness as an explicit risk to the economy and prices," she said. "This was a material shift from October, where FX was noted but less central to the outlook."
"The recent yen and JGB selling that accompanied announcements of fiscal expansion by the Japanese government may potentially invite unwanted inflation," Fink added.
