Rising Yields in Japan’s Long-Term Bonds: A Cautionary Tale for Global Fixed-Income Portfolios

Japan’s 10-year government bond yield reached 1.61% in late August 2025, marking a 0.69 percentage point increase from a year earlier and the highest level in 17 years [1]. This surge, driven by the Bank of Japan’s (BoJ) gradual exit from yield curve control (YCC) and quantitative easing (QE), has sent shockwaves through global fixed-income markets. As investors recalibrate their duration risk strategies, the interplay between Japan’s domestic policy shifts and broader geopolitical tensions—such as U.S. tariff threats and trade negotiations—has created a complex landscape for portfolio managers.

The BoJ’s Policy Normalization and Yield Curve Steepening

The BoJ’s tapering of bond purchases—from ¥5.7 trillion in July 2024 to ¥2.9 trillion by mid-2026—has allowed market forces to dictate yields, particularly in the long end of the curve [4]. By September 2025, 30-year Japanese Government Bond (JGB) yields had surged to 3.20%, compared to 0.87% for 2-year bonds, creating a steep yield curve [1]. This divergence reflects growing global inflationary pressures and regulatory pressures on insurers, which have reduced demand for long-end JGBs. The BoJ’s flexibility in adjusting its tapering pace provides a buffer, but structural vulnerabilities—such as Japan’s 260% debt-to-GDP ratio and reduced issuance of 30-year bonds—remain [1].

Domestic institutional investors, including pension funds and insurers, have maintained positions in 10-year bonds, while foreign investors have reduced holdings, exacerbating liquidity challenges [1]. A bid-to-cover ratio of 3.09 in August 2025 underscores strong domestic demand but also highlights the fragility of the market [1].

Duration Risk Management in a Shifting Landscape

The rise in Japan’s bond yields has forced investors to rethink duration strategies. Diversifying across maturities and incorporating inflation-linked instruments have become critical to hedging against inflationary pressures [4]. For example, Japanese corporations have raised $26 billion in foreign currency bonds (dollar and euro) in Q3 2025 to hedge against rising domestic rates [2].

However, the steepening yield curve has also created arbitrage opportunities for investors willing to extend duration, albeit with heightened risks. Rising yields have reduced the attractiveness of existing long-term bond holdings, particularly for life insurers facing mark-to-market losses [3]. Regulatory changes in the insurance sector, such as the shift to economic value-based solvency frameworks, have further narrowed the duration gap between assets and liabilities [4].

Geopolitical Ripple Effects on Global Markets

The U.S.-Japan trade deal, announced in July 2025, has had nuanced implications for global fixed-income markets. By reducing tariffs on Japanese auto exports and committing $550 billion in Japanese investment into U.S. infrastructure, the agreement alleviated trade uncertainties and supported Japanese equities [2]. However, it also redirected capital flows to the Eurozone, where bond yields have risen in tandem with Japan’s. The European Central Bank (ECB) now faces a delicate balancing act between addressing inflationary pressures from global supply chain normalization and mitigating risks from redirected capital flows to U.S. sectors [2].

Emerging markets (EMs) have also benefited from a weak dollar environment, with 17 of 19 EM currencies appreciating in Q2 2025. Investors are favoring EM local currency bonds, particularly in markets with strong trade fundamentals, such as Indonesia [1]. Yet, the performance of EM debt remains closely tied to currency movements, requiring careful selection of markets [1].

The geopolitical interconnectivity is further amplified by the risk of a self-reinforcing sell-off in bond markets, akin to the 2022 U.K. liability-driven investing (LDI) crisis [2]. Japanese life insurers, holding large portfolios of long-dated JGBs, face similar risks if liquidity pressures intensify.

Strategic Implications for Global Investors

For global fixed-income portfolios, the rise in Japan’s bond yields serves as a cautionary tale. Duration risk management must now account for not only domestic policy shifts but also the ripple effects of geopolitical tensions. Investors should prioritize:
1. Diversification: Allocating to inflation-linked bonds and EM local currency debt to hedge against macroeconomic uncertainty [1].
2. Currency Exposure Management: Balancing yen-based assets with foreign currency bonds to mitigate trade-related volatility [2].
3. Policy Monitoring: Closely tracking BoJ and ECB policy adjustments, as well as U.S.-Japan trade developments, to anticipate yield movements [4].

The BoJ’s potential to adjust its tapering pace and issue shorter-term debt offers a buffer, but structural imbalances in Japan’s bond market—such as its high debt-to-GDP ratio—remain a concern [1]. Meanwhile, the ECB’s May 2025 Financial Stability Review highlights the risks of geoeconomic fragmentation, urging investors to adopt a flexible, data-dependent approach to portfolio allocation [5].

In conclusion, Japan’s rising bond yields underscore the interconnectedness of global financial systems. As policymakers navigate the delicate balance between normalization and stability, investors must remain agile, prioritizing resilience over short-term yield gains.

Source:
[1] Japan’s Rising Bond Yields: A Strategic Reassessment of Fixed-Income Exposure in a Policy-Turning Landscape [https://www.ainvest.com/news/rising-demand-japanese-10-year-jgbs-strategic-signal-fiscal-monetary-uncertainty-2509/]
[2] The Impact of the US-Japan Trade Deal on Global Fixed-Income Markets [https://www.ainvest.com/news/impact-japan-trade-deal-global-fixed-income-markets-2507/]
[3] Can Japan’s Bond Market Be Tamed? [https://www.aberdeeninvestments.com/en-us/investor/insights-and-research/can-japans-bond-market-be-tamed]
[4] Japan’s Rising Bond Yields: A Strategic Reassessment of Fixed-Income Exposure in a Policy-Turning Landscape [https://www.ainvest.com/news/rising-demand-japanese-10-year-jgbs-strategic-signal-fiscal-monetary-uncertainty-2509/]
[5] Financial Stability Review, May 2025 - European Central Bank [https://www.ecb.europa.eu/press/financial-stability-publications/fsr/html/ecb.fsr202505~0cde5244f6.en.html]