Government bonds are traditionally viewed among the safest investment assets, largely because the likelihood of the issuer—the government—defaulting is considered relatively low. Within the global landscape of major government bond markets, Japan's ¥7.5 trillion government bond market has been regarded as one of the most stable for decades. Recently, however, investors have begun demanding higher returns to hold Japanese government bonds, as they brace for elevated interest rates and other emerging risks in Japan.

This shift has pushed bond prices down, while yields—which move inversely to prices—have climbed sharply. In early September, the 10-year Japanese government bond yield rose to 3%, a level not seen this century. Concerns are mounting over whether there is sufficient demand to absorb Japan's massive government bond supply; otherwise, yields could climb even higher, with implications that may extend well beyond the bond market. Persistently rising yields would lift borrowing costs across all sectors in Japan, affecting households, businesses, and the government itself—a particularly pressing concern given the country's already one of the highest debt burdens globally. The 10-year JGB yield has now reached its highest level since 1996, driven by several converging factors.

Rising Interest Rates

In June, the Bank of Japan raised its policy rate to 1%, the highest level in 31 years. While still low by global standards, this hike marks a significant departure from decades of ultra-low and negative interest rate policies. Investor conviction is growing that the BOJ will hike again soon, with overnight index swaps now fully pricing in a rate increase in September. Inflation persistently above the BOJ's 2% target, coupled with higher energy costs and additional pressures from a weaker yen, further strengthens the case for continued monetary tightening.

The anticipated return to higher interest rates is helping push government bond yields upward. When the BOJ raises its policy rate, returns on other low-risk investments tend to rise as well. This makes existing bonds less attractive, driving their prices down and yields up. Expectations of further future hikes produce a similar effect, and recent signals from policymakers have reinforced this outlook. Takata Hajime, one of the BOJ's most hawkish board members, has not ruled out the possibility of significant or consecutive rate hikes, suggesting the central bank could tighten policy more rapidly. US Treasury Secretary Scott Bessent has also publicly pressured Japan to raise interest rates.

BOJ's Retreat from the Bond Market

The Bank of Japan has long been the dominant buyer of Japanese government bonds. For years, massive bond purchases were a cornerstone of the BOJ's efforts to stimulate the economy and escape prolonged deflation—buying large quantities of bonds pushed prices up and yields down, thereby lowering borrowing costs and encouraging consumption and investment across the economy. Starting around 2010, the BOJ gradually expanded its bond purchases, and by 2023, it held approximately 54% of all outstanding Japanese government bonds.

Now that Japan has moved past deflation and no longer relies on bond buying to support the economy, the BOJ is scaling back its presence in the bond market. This move is partly aimed at restoring market functionality after years of large-scale purchases that suppressed yields and reduced trading activity among other investors. As of July, the BOJ's holdings of Japanese government bonds had decreased by ¥47.8 trillion from a year earlier, the largest decline since data collection began in 1997. The BOJ's bond holdings are shrinking at a record pace, but its exit has left a significant void in the market, with private investors such as commercial banks and life insurance companies reluctant to fill the gap, keeping demand persistently weak. Although the BOJ has indicated it will stop further reducing its bond purchases starting next April, this does not mean its massive holdings will cease to decline. As existing bonds mature, even if the BOJ halts active reductions in new bond purchases, its portfolio will continue to shrink.

Concerns Over Japan's Debt Burden

Fiscal worries are also weighing on Japanese government bonds. The heavily indebted government has unveiled an economic development roadmap, planning investments exceeding ¥370 trillion ($2.3 trillion) over the 14-year period through 2041. While it remains unclear how much of this will involve new government spending, the plan is unprecedented in both scale and scope. The prospect of increased government spending unsettles some investors, as new expenditures and tax cuts, without alternative funding sources, typically mean the government must borrow more by issuing additional bonds. When bond supply increases, prices generally fall—and investors, wary of being stuck with depreciating assets, may sell off, further pressuring the bond market.

More government spending lies ahead. Prime Minister Takichi Sanae plans to cut the food sales tax for two years but has not specified how this measure will be funded. The Defense Ministry is seeking approximately $56 billion in spending for the fiscal year starting in April, and with Sanae preparing to launch a new military expansion plan later this year, the final figure could rise significantly.

Global Bond Selloff

Investors have been offloading government bonds in other regions, driven by concerns over energy-driven inflation and increased government spending. This selloff has pushed borrowing costs in several major economies to multi-year highs. In the UK, the 10-year gilt yield has risen to levels last seen in 2008, while the 30-year yield hit its highest since 1998. Germany's 10-year Bund yield has climbed to its highest since 2011, and the US 10-year Treasury yield has reached highs not seen since January 2025.

As investors compare returns offered by different countries' government debt, rising yields in other major bond markets can also exert upward pressure on Japanese yields. For instance, if US Treasuries suddenly offer higher returns, Japanese bonds at existing yield levels become relatively less attractive to investors, creating downward pressure on JGB prices and pushing yields higher. There are reasons to believe the pressure on global bond markets could persist. Traders are increasingly betting that some central banks will hike rates this year or delay anticipated cuts, which could continue to weigh on bond prices and keep global borrowing costs elevated.