Japan’s bond market is sending shockwaves through global financial circles as its long-dated government bond yields climb toward historic highs. The spike in yields has raised concerns about capital repatriation from Japanese investors, potentially setting the stage for a major unwinding of global carry trades.
As of late May, yields on Japan’s 40-year government bonds reached a record high of 3.689%, before easing slightly to 3.318%. That’s nearly a 70 basis point increase this year. Yields on the 30-year and 20-year bonds also surged, now standing at 2.914% and over 2.6%, respectively. This trend has reignited fears that Japan could be on the verge of triggering a global financial disruption.
Carry trades involve borrowing in low-yielding currencies like the Japanese yen and investing in higher-yielding assets elsewhere, notably U.S. stocks and bonds. But as Japanese yields rise, these trades become less profitable. If yields climb much further, Japanese investors may begin withdrawing capital from abroad and redirecting it back to domestic bonds.
Such a move would strengthen the yen, making Japanese exports more expensive and placing downward pressure on global markets, especially U.S. equities. The yen has already appreciated over 8% this year, partly due to expectations of repatriated funds.
One structural factor behind the rising yields is that Japanese life insurance companies — typically big buyers of long-dated bonds — have largely met their investment quotas, reducing demand in the market. At the same time, the Bank of Japan has reduced its bond purchases, leading to a supply-demand mismatch that’s fueling the yield surge.
This poses a risk to financial markets globally. Japan remains the world’s second-largest creditor, with $3.7 trillion in net external assets. A wave of capital returning home would reduce global liquidity and tighten financial conditions, possibly extending the bear market in risk assets.
Despite the fear, some analysts argue that the potential carry trade unwind may unfold gradually, unlike the sharp sell-off seen in August 2024. The narrowing yield gap between U.S. and Japanese short-term debt reduces the incentive to short the yen. Plus, most of Japan’s foreign holdings are in U.S. equities rather than Treasurys, which provides some buffer.
Still, forex traders and global investors should be on alert. Rising Japanese yields and a stronger yen threaten the very foundation of global capital flows that have supported U.S. asset markets for years. If conditions persist, a slow but steady erosion of carry trade dynamics could reshape currency and bond markets in the months ahead.
