Fiscal and inflation concerns persist as Japan's 10-year government bond yield climbs to its highest level since 1999.

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Under the dual concerns of fiscal expansion and intensifying inflationary pressures, Japan's government bond market faced selling pressure at the beginning of the new year, with long-term bond yields rising significantly.

The benchmark 10-year Japanese government bond yield rose as much as 5 basis points to 2.12% on Monday, reaching its highest level since 1999. At the same time, the yields of 20-year and 30-year government bonds also followed suit and increased. This upward movement in yields came on the heels of a selloff in long-term U.S. Treasuries, as traders reassessed the impact of increased global defense spending on the bond market against the backdrop of rising geopolitical risks.

Japan's government, led by Prime Minister Sanae Takaichi, approved a budget totaling 122.3 trillion yen (approximately $780 billion) last month, with defense spending set to rise to a record level next year. Meanwhile, volatility in the currency market has further heightened investor unease. Although the yen rose by less than 1% against the dollar in 2025 after four consecutive years of decline, its overall weak stance has sparked concerns in the market about delayed action from the Bank of Japan in controlling inflation.

“Reflation” Policy Intent Pushes Pressure on Long-Term Bonds

Market analysts point out that the government's fiscal policy orientation is a key factor driving up long-term yields. Yusuke Matsuo, an economist at Mizuho Securities Co., wrote in a report on Monday that as long as market participants continue to perceive that Prime Minister Sanae Takaichi's government holds “reflation” policy intentions, Japanese long-term government bond yields may continue to face upward pressure.

However, Matsuo also noted that some of the pressure may be alleviated. The Japanese Ministry of Finance plans to reduce the issuance of super-long-term bonds in the fiscal year starting from April, a move that may help balance supply and demand to a certain extent.

Cautious sentiment in the market is rising ahead of Tuesday's upcoming auction of 10-year Japanese government bonds. Although current yield levels are high and newly issued bonds generally have some appeal, this is not enough to completely dispel market doubts.

Keisuke Tsuruta, Senior Bond Strategist at Mitsubishi UFJ Morgan Stanley Securities Co., said that while there may be some dip-buying demand, it's hard to be optimistic about the bond market as long as concerns persist about the Bank of Japan lagging behind the inflation curve.

The turbulence in Japan’s bond market is not an isolated incident but has been profoundly affected by the global macro environment. Previously, U.S. long-term bonds experienced a selloff, leading to a steepening of the yield curve. Traders are pricing in potentially increased defense spending under the Trump administration amid escalating geopolitical risks, and such sentiment is spilling over into the Japanese market, resonating with Japan's record defense budget.

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