Japan's borrowing costs have surged to a 30-year high, with concerns over a debt crisis unsettling global bond markets.

Japanese government bonds are experiencing sustained sell-offs, with long-term yields soaring to rare highs not seen in decades, intensifying market concerns over fiscal sustainability.

During the Asia-Pacific session on Thursday, Japan’s benchmark 10-year government bond yield rose to 2.883%, the highest level since 1996.

Meanwhile, the 40-year bond yield rose 5 basis points to 4.055%, while the 30-year yield has surpassed 4% this year, approaching the record high set in May.

The 14-year, approximately $2.3 trillion fiscal spending plan led by Japanese Prime Minister Sanae Takaichi is seen by investors as the main driver of the current sell-off in long-term government bonds.

Although the Bank of Japan last month raised policy rates to 1%, it remains cautious about further tightening. Coupled with a persistently weak yen, this has significantly increased market sensitivity to fiscal risks. Multiple fund managers have warned that if the situation continues to worsen, volatility in Japanese government bond yields could spill over into global bond markets, intensifying financing pressures for other major economies.

Fiscal worries and easing expectations add pressure to long-term interest rates

The core contradiction in this round of Japanese bond sell-off lies in the conflict between fiscal expansion and the normalization of monetary policy.

Aberdeen Investment Director Alex Everett stated:

The Bank of Japan remains cautious in further tightening, the yen is persistently weak, and concerns about fiscal policy linger. These factors combined make the long end of the government bond yield curve particularly fragile.

Pricing of long-term risk is already obvious in the market. The yield spread between Japan’s 10-year and 2-year government bonds has widened from less than 1 percentage point in April to the current 1.4 percentage points. In contrast, similar spreads in major bond markets like the US and Germany have recently remained flat or narrowed, forming a sharp contrast.

Ultima Markets senior analyst Elon Gu pointed out that the 1.4% spread is already a three-decade high, suggesting that the market is repricing risk for Japan’s heavy long-term debt burden. Aviva Investors’ Head of Fixed Income Fraser Lundie commented:

Inflation can no longer be ignored, government borrowing remains large, and the Bank of Japan is pursuing policy normalization. This combination has driven market sensitivity to fiscal dynamics to its highest in years.

Huge debt scale, “debt trap” risk emerges

Japan’s rising borrowing costs are amplifying its already elevated sovereign debt risks.

Japan’s sovereign debt scale is more than 200% of GDP. Goldman Sachs senior economist Tomohiro Ota warned that Japan may fall into a “vicious cycle”—fiscal anxieties push up interest expenses, further increasing fiscal pressure. Stephen Jones, chief investment officer at Aegon Asset Management, commented:

The current situation reflects Japan’s accumulation of the world’s largest sovereign debt under the assumption that “money is always free.” The market is now aggressively breaking this assumption… Tokyo must refinance past debt and raise funds for the future at costs unseen in a generation.

Société Générale rates strategist Stephen Spratt warns that Japan’s government borrowing costs may rise at a pace faster than revenue growth, eventually worsening the debt dynamics. He says:

We believe the tipping point lies somewhere above a 3% yield on the 10-year bond, but once the 3% level is breached, the market will begin to question the situation.

Some institutional investors worry that if Japanese government bond yields rise sharply, they may attract capital back from other sovereign bond markets, driving global yields up overall and further tightening the financing environment for countries like the UK, whose long-term borrowing costs have already reached multi-decade highs earlier this year.

Whether the current pressure in Japan’s bond market will evolve into a systemic shock depends on the speed of Bank of Japan policy adjustment and the actual implementation of Takaichi’s cabinet fiscal plans. The market remains highly tense.

Yen and bonds weaken in tandem, abnormal signals trigger concerns

This year, the simultaneous decline in the yen and Japanese government bond prices is unusual, as these two assets typically move inversely with interest rate expectations.

Despite multiple previous Bank of Japan market interventions, the yen fell again to 162.46 on Thursday, hitting a 40-year low.

Analysts believe that the simultaneous pressure on currency and bonds indicates that the market is questioning both Japan’s monetary policy stance and fiscal credibility, resulting in negative resonance.

On the policy front, last month’s Bank of Japan meeting announced plans to stop reducing the monthly bond purchase volume next year, maintaining it at about 2 trillion yen (about $12.5 billion).

Unlike central banks such as the Federal Reserve and Bank of England, which have begun shrinking their balance sheets, the Bank of Japan is still buying bonds, providing some degree of stability to the government bond market.

However, this approach is also subject to criticism. Some investors worry Japan is sliding into a so-called “fiscal dominance” dilemma, where policy rates are artificially suppressed and inflation used to dilute government debt. If Japan’s substantial financial assets held by the government are included, its net debt to GDP ratio approaches 100%.

Mitsubishi UFJ Financial Group (MUFG)’s Lee Hardman says the Bank of Japan’s cautiousness in raising rates is strengthening the market’s “perception” of this strategy.

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