After 30 years, back to 3%! Japan's 10-year government bond yield breaks through the significant constraint of the "zero interest rate era."

On Tuesday, the yield on Japan's 10-year government bonds briefly rose to 3%, marking the first time this has occurred since the turn of the 21st century. This signifies an important milestone in the country's bond market as it returns to normalization after the benchmark borrowing cost lingered near zero for many years. The yield increased by six basis points that day, reaching the 3% level, the highest since 1996. This rise is particularly notable as it was only half of the current level a year ago, underscoring the rapid changes impacting the Japanese economy and global financial markets. Since the Bank of Japan ended the last negative interest rate policy in the world in 2024, the operational logic of the country's bond market has fundamentally shifted. Previously constrained by the Bank of Japan's price controls, government bonds are now driven more by independent decisions made by domestic and foreign investors. The basis for buying and selling has shifted to inflation and growth prospects, as well as the risk-return profile of Japanese debt relative to other assets, rather than the guidance of central bank policy. The rise in yields will exert pressure on the existing investment portfolios through market value losses, but it also creates more attractive entry points for fixed-income investors, said Wee Khoon Chong, a senior market strategist at BNY Mellon in Asia-Pacific. Japanese government bonds are becoming a credible allocation option again. Despite the Bank of Japan still holding a massive amount of domestic government bonds, the rising yields are encouraging local institutions to increase their holdings, while the trading activity of global funds in this market continues to ramp up. Currently, international investors account for about two-thirds of the monthly spot trading volume of Japanese government bonds, significantly higher than the 12% recorded in 2009. These changes coincide with an overall rise in global bond yieldsconcerns over inflation are exacerbated by rising oil prices, and market expectations for Federal Reserve interest rate hikes are increasing, further elevating volatility in the Japanese market. The Bloomberg Global Sovereign Bond Yield Index increased for the fourth consecutive trading day on Monday, rising to 3.72%, the highest level since mid-2008. The rise in Japanese government bond yields also reflects a comprehensive re-inflation of the country's once-stagnant economy, significant increases in corporate profits, and a simultaneous rise in wage levels. For the Japanese government, the challenge is to ensure that economic growth is effectively translated into adequate tax revenues to cover the increased financing costs accompanying the rise in yields. In this context, Japan's Ministry of Finance has budgeted a record 36.6 trillion yen (approximately 230 billion USD) for debt repayment in its preliminary budget request for the next fiscal year. Following the auction of 10-year Japanese government bonds, the yield slightly retreated, with auction demand roughly in line with the 12-month average. As investors increased bets on the Bank of Japan raising interest rates again soon, possibly this month or the next, yields on government bonds of all maturities rose. Reports indicate that Prime Minister Fumio Kishida's government supports a recent rate hike in response to the persistently weak yen. U.S. Treasury Secretary Scott A. Posen has also pressured the Bank of Japan to move forward with its next monetary policy actions. Overnight index swap data indicate that the market implies a 92% probability of the Bank of Japan raising rates before September, while a rate hike in October is fully priced in. Concerns about fiscal sustainability are also reflected in the rising yields. Prime Minister Kishida has announced an unprecedented spending plan aimed at reshaping the Japanese economy, but the government has yet to clarify how it will fund the reduction of the food consumption tax. As yields rise, investors are becoming increasingly sensitive to the prospect of the government increasing debt. While some bond investors may find the current levels attractive and start buying, more participants are still betting that yields will rise further, stated Hiroshi Namioka, chief strategist at T&D Asset Management. Additionally, fiscal concerns could trigger further weakening of the yen, so I believe it will take time for meaningful capital inflows to return.