Japan's Bond Yields Rise 18.6% on Strong Economic Fundamentals

The recent increase in Japan's long-term government bond yields has raised concerns about its potential impact on the economy. However, economic research indicates that the negative effects may be limited. The rise in the 10-year bond yield is primarily driven by strong economic fundamentals in both Japan and the United States, rather than policy tightening or market volatility. This trend could even signal a return to normal economic conditions.

The surge in yields for bonds with maturities exceeding 20 years is noteworthy, but its impact on GDP is likely to be minimal. This is because the number of borrowers relying on such long-term financing is relatively small. The current rise in yields is largely attributable to favorable macroeconomic conditions in Japan and the United States. Historical comparisons show that while yields have risen to similar levels in the past, the current increase is more driven by solid economic fundamentals rather than policy tightening or market instability.

As of the time of writing, Japan's 10-year government bond yield stands at 1.51%, close to the level seen in June 2009. However, a deeper analysis using an asset decomposition model reveals that the current situation differs from the past. While monetary policy factors contributed to a 37.5 basis point decrease in yields in 2009, the current rise is driven by macroeconomic shocks in Japan and the United States, which have pushed yields up by 18.6 basis points and 39.6 basis points, respectively. This indicates that despite the Bank of Japan's efforts to normalize policy, the current stance remains more accommodative than in 2008. This is consistent with the central bank's continued holding of a large amount of Japanese long-term government bonds, equivalent to nearly the country's GDP.

From a real interest rate perspective, borrowing costs remain negative. The 10-year breakeven inflation rate is 1.64%, resulting in a real 10-year interest rate of -0.12%. The Bank of Japan estimates Japan's natural interest rate to be between -1.0% and +0.5%. Given this range, describing the current real yield as "restrictive" would be an overstatement.

Despite the recent sharp increase in yields for bonds with maturities exceeding 20 years, the economic impact is likely to be minimal. Borrowers of such long-term debt typically engage in infrastructure or real estate projects that take years to complete, diluting any short-term impact on GDP. Additionally, Japanese companies, having developed a more conservative financial approach during the prolonged period of stagnation, rely more on internal cash flows for investment rather than long-term borrowing. As a result, corporate capital expenditure is less sensitive to interest rate changes.