Japan’s government has issued an unusual warning about rising government bond yields and shifting debt ownership, highlighting risks linked to the Bank of Japan’s ongoing reduction in bond purchases. The alert was included in the country’s newly approved annual economic and fiscal policy guidelines, which will shape upcoming budget decisions.
“We must continue efforts to further promote domestic ownership of government bonds to avoid spikes in long-term interest rates caused by supply-demand imbalances,” the guidelines stated.
The warning follows a recent selloff in Japan’s bond market that briefly pushed yields on super-long Japanese government bonds (JGBs) to record levels. The government debt market—especially long-dated instruments—is under pressure from the BOJ’s tapering of purchases, declining interest from life insurers, and intensifying fears over Japan’s fiscal health.
Currently, the BOJ holds 46% of all JGBs but has been steadily slowing its purchases as it gradually winds down its massive asset-buying program. According to sources, the central bank is unlikely to alter its tapering policy at next week’s meeting but may consider slowing the pace starting next fiscal year to avoid major market disruptions.
As the BOJ scales back, the role of domestic private-sector banks becomes more critical. However, regulatory capital requirements may limit their capacity to absorb interest rate risk. Foreign investors have increased their JGB holdings over the past decade, but their investment horizons are shorter than those of traditional domestic players like insurers, said Koichi Sugisaki, macro strategist at Morgan Stanley MUFG Securities.
“A situation where these buy-and-sell investors are holding large interest rate risks is inherently unstable, if not outright dangerous,” Sugisaki noted. “It’s like having ‘magma’ ready to erupt at any moment, should something trigger it.”
As of the end of last year, banks held 14.5% of JGBs (including treasury discount bills), insurance firms 15.6%, and foreign investors 11.9%.
In response to mounting risks, the government is preparing several policy tools to attract more stable domestic investment. These include issuing new floating-rate JGBs tied to short-term interest rates and expanding the eligibility criteria for retail investor-targeted bonds to include non-profit entities and unlisted firms.
The government is also considering repurchasing some low-interest super-long JGBs issued in earlier years to improve supply-demand dynamics, alongside expected cuts in future super-long bond issuance.
The bond market remains jittery amid political calls for increased fiscal stimulus. While Prime Minister Shigeru Ishiba has resisted opposition demands for tax breaks to counter inflation, he has directed the ruling Liberal Democratic Party to offer cash handouts during its campaign for the upcoming upper house elections in July—avoiding reliance on new deficit-financing bonds.
In its updated fiscal guidelines, the government formally pushed back its goal of achieving a primary budget surplus. The previous target of fiscal 2025 has now been revised to “as early as possible during fiscal years 2025 to 2026.”
As markets reacted to both global tensions and domestic financial concerns, stocks fell sharply on Friday. The Dow dropped 1.8%, the S&P 500 lost more than 1%, and the Nasdaq declined by 1.3%.
