Rising Fiscal and Monetary Risks in Japan's Bond Market: A Warning for Global Fixed-Income Investors

Japan's government bond (JGB) market, long a cornerstone of global fixed-income stability, is showing troubling signs of strain as fiscal and monetary pressures converge. Recent auction dynamics, liquidity metrics, and institutional behavior paint a picture of a market teetering between resilience and fragility. For global investors, the implications are clear: a potential liquidity crisis in Japan's bond market could reverberate far beyond its borders.

Auction Performance: Mixed Signals Amid Rising Yields

The bid-to-cover ratios for JGB auctions in Q3 2025 reveal a bifurcated picture. The 10-year JGB auction in October 2025 saw a decline in demand, with a bid-to-cover ratio of 3.34, down from 3.92 in September, as investors grew wary of rising yields and the possibility of a Bank of Japan rate hike. This contrasts sharply with the 30-year JGB auction in December 2025, which achieved a robust bid-to-cover ratio of 4.04-the highest since May 2019-despite record-high yields. However, the subsequent 30-year auction in early January 2026 saw a drop to 3.31, signaling a moderation in demand. These fluctuations highlight the market's sensitivity to shifting expectations about monetary policy and fiscal sustainability.

Secondary Market Liquidity: Glimmers of Strength, Persistent Weaknesses

While primary auction performance is mixed, secondary market liquidity metrics offer a more nuanced view. In Q4 2025, the Japan Exchange Group (JPX) reported a surge in trading activity for 20-year JGB Futures, with July 2025 volumes reaching 12,099 contracts (JPY 120.99 billion in face value)-the highest since the product's 2014 relaunch. Annual trading volumes for 20-year JGB Futures in 2025 hit 196,682 contracts, the highest since 1988. Yet, these gains are tempered by low foreign participation, which accounts for just 10% of trading volume in 20-year futures, compared to over 70% in 10-year contracts. This disparity underscores lingering challenges in attracting global capital to longer-dated JGBs.

Bid-ask spreads in the cash JGB market also provide insight. A liquidity enhancement auction on December 23, 2025, reported an average accepted spread of ▲0.050%, reflecting secondary market conditions. While this is relatively tight, it masks broader concerns about market depth, particularly as institutional selling pressures persist.

Institutional Underperformance: Insurers' Exit and Market Volatility

The most pressing risk lies in institutional underperformance, particularly among Japanese life insurers. These institutions are offloading JGBs at an unprecedented pace due to a sharply negative duration gap of -1.48 years, which amplifies their vulnerability to rising interest rates. As insurers unwind long-duration holdings to mitigate mark-to-market losses, they are exacerbating market volatility and reducing liquidity. This self-reinforcing cycle is compounded by the BOJ's tightening of monetary policy and reduced balance sheet support, which have weakened the market's capacity to absorb large-scale sales.

The consequences are already visible. Market depth in the JGB market has eroded, and volatility has spiked as insurers shift portfolios toward shorter-term assets. If this trend continues, it could trigger a liquidity spiral, where falling liquidity further drives up yields, forcing more selling-a scenario reminiscent of the 2018 U.S. Treasury market turmoil.

Implications for Global Investors

For global fixed-income investors, Japan's bond market is no longer a safe haven. The interplay of fiscal pressures (aging demographics, rising debt/GDP ratios) and monetary tightening is creating a toxic mix. The BOJ's reduced role as a buyer of last resort means that even minor shocks could trigger sharp price swings. Additionally, the low foreign participation in longer-dated JGB futures suggests that global investors are not yet fully exposed-but that could change rapidly if liquidity deteriorates further.

Investors should also monitor the potential for spillovers. A JGB liquidity crisis could destabilize global bond markets, particularly as central banks elsewhere grapple with their own tightening cycles. Hedging strategies and diversification are critical, but the key takeaway is clear: Japan's bond market is no longer a passive asset class. It demands active scrutiny.

Conclusion

Japan's JGB market stands at a crossroads. While recent auction results and secondary market activity suggest some resilience, the underlying risks-institutional underperformance, eroding liquidity, and policy uncertainty-are mounting. For global investors, the lesson is stark: complacency in Japan's bond market is no longer an option. As the BOJ's tightening continues and insurers' selling pressures persist, the next chapter in Japan's fiscal and monetary saga could redefine the landscape for fixed-income markets worldwide.