The global bond market sell-off spreads! The yield on Japan's 10-year government bonds has surged to a new high since 1996.

Analysis warning, as the last anchor of global low interest rates wobbles, yen arbitrage trading faces the risk of collapse, and market volatility may further intensify.

Written by: Dong Jing, Wall Street Insights

The Japanese bond market reopened after the week-long holiday, immediately caught up in the global bond sell-off wave. The yield on Japan's 10-year government bonds surged to its highest level since August 1996 on Thursday, coinciding with U.S. Treasury yields soaring to multi-decade highs, marking a historic synchronous repricing occurring across major global debt markets.

The yield on Japan's 10-year government bonds rose by 10 basis points to 3.075% on Thursday, while the 5-year yield increased by 9.5 basis points to 2.37%, with yields across all maturities climbing. Meanwhile, the U.S. 10-year Treasury yield also reached a nearly 19-year high, the 30-year Japanese government bond yield rose by nearly 7 basis points to 4.134%, and the 5-year yield hit a record high of 2.345%.

This sell-off wave was driven by multiple overlapping factors: a rebound in oil prices intensified inflation concerns, stronger-than-expected U.S. economic data reinforced market expectations for continued interest rate hikes by the Federal Reserve, and weak demand for a $70 billion auction of 5-year U.S. bonds directly pushed yields upward. The Japanese bond market faced increased pressure upon reopening after the three-day holiday, with declines particularly severe.

The U.S. Bond Sell-off as the Trigger

The core driving force behind the recent turbulence in the global bond market comes from the U.S. According to UOB's report, the rebound in oil prices, stronger-than-expected U.S. PMI data, and weak demand for the $70 billion 5-year treasury auction combined to push the yield on 5-year U.S. bonds above 5%, driving the yield curve of U.S. Treasuries up to nearly 20-year highs.

Strong economic data prompted the market to reassess the Fed's monetary policy path, further cooling investor expectations for rate cuts in the near term, thereby putting pressure on long-end rates. This trend quickly transmitted to major global bond markets, with the Japanese bond market being the first to bear the brunt.

The Bank of Japan's Rate Hike Signal Triggers a Double Impact

The pressure on the Japanese bond market did not stem only from external factors. The Bank of Japan raised its benchmark interest rate last Friday and hinted at the possibility of further tightening monetary policy; however, traders felt disappointed due to the lack of clearer guidance on the pace of future actions.

This statement subjected Japanese government bond yields to dual pressures: first, the market's expectation for further rate hikes by the Bank of Japan continues to rise; second, the spillover impact from the global repricing of long-term borrowing costs. The combination of these two forces led to concentrated selling pressure on the Japanese bond market upon reopening after the holiday.

Notably, according to Bloomberg, earlier this month, after U.S. Treasury Secretary Scott Bessent publicly expressed expectations for Tokyo and the Bank of Japan to take action to support the weak yen, Japan's benchmark borrowing costs rose to their highest level in 30 years. This further increase indicates that the Japanese bond market is currently in the most severe rate upcycle it has seen in many years.

Fiscal Concerns Intensify Market Worries

In addition to monetary policy factors, the prospects of Japan's government fiscal spending also unsettle investors. It is reported that the Japanese government is considering setting the medium-term defense budget target at 3.5% of GDP to align with NATO and other U.S. allies' standards. This news has heightened market concerns about Prime Minister Kishida Fumio's overall spending plan.

Under the dual pressure of sustained inflation and expectations of fiscal expansion, investors are demanding higher risk premium compensation for holding Japanese government bonds, further driving this wave of sell-off. The continuous rise in yields means that the Japanese government's future debt financing costs will rise significantly, again drawing market attention to fiscal sustainability issues.

Analysts believe that the synchronous significant rise in the Japanese and U.S. bond markets marks that the long-term borrowing costs of major global economies are undergoing systemic repricing.

The uniqueness of the Japanese bond market lies in its long-standing position as an important anchor of the global low-interest-rate environment. As Japan's government bond yields accelerate upward, some global asset allocation strategies relying on yen arbitrage face pressure for re-evaluation, and market volatility may further increase.