Why has there been a significant change in Japanese government bonds?

Rising yields on Japanese government bonds over the long run indicate more than just inflation but also growing anxiety about the future

There aren't many people in the investment industry today who can recall a period when the yields on Japanese government bonds (JGBs) weren't constantly declining. They reached their zenith in 1990, shortly after the bubble burst, and then fell for the majority of the next thirty-five years.

Shorting JGBs has been referred to as the "widow-maker" for the duration of my career. Regardless of how low yields were, they always managed to drop even lower, eliminating anyone who was foolish enough to wager that the bottom had been reached.

The significant increases in longer-dated JGBs over the past year may not have received as much attention as one might anticipate because of this. It is natural for anyone who has been raised to believe that JGB yields will always be low to have doubts about its sustainability. This is only a temporary disruption; they will soon descend once more.

However, there appears to have been a fundamental change. Comparable to the 30-year bund, which yields 3.1 percent, the 30-year JGB currently yields 2.9 percent. It had increased slightly to nearly 3.2 percent prior to the Bank of Japan announcing that it would slow down its withdrawal from quantitative easing (QE), and the Ministry of Finance announcing that it would issue less ultra-long-dated debt going forward.

Because low-yielding Japanese debt has been a major source of funding for numerous international carry trades, the ramifications of this are substantial not only for Japan but also for global markets. Invest in higher-yielding assets in one currency, borrow at low rates in another, pick up the difference in returns, and hope you can close the trade before something happens, like a significant currency loss.

Japan's 30-year government bond yield to maturity is shown in a line graph from 2006 to 2023, indicating a notable increase in yield.

Everywhere, old JGBs indicate uncertainty.

The increased yields on long-dated JGBs do not, however, portend a normalization of Japanese monetary policy anytime soon. Five-year yields are still more than a percentage point apart, with the 30-year JGB and 30-year bund now in line, but markets are pricing in a very drawn-out adjustment (0.97 percent vs 2.18 percent). According to the market, this long-term distortion in global markets may eventually unwind, which would be bullish for the yen in the long run but not for the short term. Whether or not this is overly optimistic is debatable; rates should increase more quickly if inflation stays high (3.5% in May).

Rather, long-dated bonds are indicating a great deal of uncertainty in Japan and other countries. Consider the US 30-year Treasury, which currently yields 4.8%. Because the 30-year inflation-linked Treasury is yielding roughly 2.5 percent (i.e., the rate of inflation required for them to return the same is just 2.3 percent), this doesn't appear to be due to concerns about runaway inflation in particular. Instead, locking up capital for so long just seems more imprudent. Investors are concerned about politics (the UK 30-year gilt had ticked up to 5.4 percent at the time of writing), the possibility of issuing large amounts of bonds to finance the government's increased spending, and much more. They have good reason to be concerned, and the yields that are currently available still seem like a very small reward for those risks.