Japan’s long-standing role as a “quiet stabilizer” of global bond markets may be about to change, and the U.S. Treasury could be among the first to feel the effects. Japanese investors and institutions are among the largest holders of foreign government bonds. At the end of 2024, they held 12.4% of foreign-held federal debt (securities worth more than $1 trillion), making them the top holders of U.S. debt abroad. Japan is also a major holder of government bonds issued by governments in Europe and Asia. Much of the appeal for Japanese investors is the relatively high yields offered by countries such as the United States, Germany, and the United Kingdom, which also offer relative political and economic stability. Bond yields and prices move in opposite directions. When investors are spooked by a government’s fiscal policy, a country’s bonds can be sold off widely, pushing yields higher. Japan’s government bond yields have been historically low, but when Sanae Takaichi became prime minister in October, her tax cuts and spending plans sparked a sell-off. The yield on the benchmark 10-year Japanese government bond has recently been trading around 2.12%, falling in recent weeks after yields hit a 30-year high. JP10Y YTD Line Japanese 10-Year Government Bond Over the past year, the spread between the Japanese 10-year bond and the US 10-year bond has narrowed by approximately 115 basis points. Spreads between Japan and the UK narrowed by about 92 basis points, and between Japan and Germany by about 45 basis points. Nigel Green, chief executive of wealth advisory De Vere Group, warned that investors do not appear to have fully priced in the potential knock-on effects of rising Japanese yields on global bond markets. He said that for many years Japanese financial institutions had been “forced to move overseas because domestic yields were negligible.” Green added that “persistently high domestic bond yields” will change the game. “A steady return to government debt would be enough to change global pricing,” Green told CNBC. “Japan has become a structural buyer of U.S. Treasuries and major developed market bonds. If we release some of our bids, yields will adjust upwards.” De Vere said he expects these changes to lead to a sustained rise in the risk premium on long-term bonds, steepening yield curves across major markets and significantly tightening financial conditions globally. “Japan has been exporting its savings for a generation, and if more of that savings stays at home, global bond markets will lose one of their quiet stabilizers,” Green added in an email. “Markets still seem to be behaving as if Japan’s volatility is a temporary disruption rather than a regime change, which we believe is a mistake.” He warned that given the size of Japan’s holdings, U.S. Treasuries are the bonds most at risk, followed by European government bonds, which are in dire financial conditions. “Markets that have relied on Japan’s stable duration demand are expected to become vulnerable,” Green said. Derek Halpenny, head of research for global markets EMEA and international securities at Japanese bank MUFG, told CNBC that it “makes perfect sense” for Japanese investors to consider keeping more capital in the domestic bond market. “I don’t think the specific yield level required will be the catalyst,” he said, arguing that other factors, such as increased investor confidence in Japan’s economic management, will be more important. According to Mr. Halpenny, since Prime Minister Takaichi took office, he has advocated prudent fiscal policy management going forward, which is leading to a decline in yields. But Halpenny added that the Bank of Japan’s monetary policy is widely considered to be too accommodative, and that two or three rate hikes are needed to restore bond investors’ confidence in the Bank. In 2024, the Bank of Japan ended its decade-long economic stimulus program and continued to raise interest rates several times. The central bank kept the key policy interest rate unchanged at 0.75% in January, after raising it to the highest level since the 1990s. Halpenny said that with rising interest rates and subdued inflation, “we are approaching conditions for improving investor sentiment for Japanese government bonds.” “However, we expect this to develop more gradually, with new investment staying domestic and investors gradually increasing their diversification into government bonds, as domestic investment expansion is unlikely to occur suddenly (unless there is some shock).” Halpenny added that the team was keeping a close eye on flows from pension funds such as the Government Pension Investment Fund (GPIF), but said there was nothing in the data to indicate changes were afoot yet. At the end of the third quarter of the fiscal year, 50% of GPIF’s investments were in the fixed income market. Nearly half of these holdings were in foreign bonds, with total investment amounting to 72.8 trillion yen ($470.6 billion). ‘A risk that requires continued monitoring’ James Ringer, global unrestricted bond fund manager at Schroders, told CNBC that the repatriation of Japanese capital is a “risk that requires ongoing monitoring” given how Japanese government bond yields are trading. “But there’s more to this story than just looking at yields,” he says. “Volatility in government bonds remains relatively high and liquidity relatively low. We will need to see both improve before large-scale repatriation occurs, especially for certain types of Japanese investors.” He added that the benefits of diversification continue to be emphasized in a post-COVID-19 world. “By investing overseas, Japanese investors can achieve diversification and gain broader access to a highly rated and liquid bond market,” Ringer said. DeVere’s Green said that even if Japanese investors maintain their holdings overseas, changes in Japanese government bond yields could have an impact. “Japan has proven from developed countries that ultra-low interest rates can continue indefinitely. Japan has fixed the lower bound on expectations, but this scenario appears to be changing,” he said. “Once the eventual holdout normalizes, the case for a permanent cap on yields weakens everywhere, so investors should consider pricing in the possibility of structurally higher interest rates in developed markets.” Green added that Japan has historically provided stability through predictability, as domestic investors hold most government debt and “have built a reliable, price-insensitive foundation.” “If this system becomes more yield-sensitive and more volatile, it will change the tone of global bonds,” he said.
