Rising JGB Yields and the Implications for Global Capital Flows

The Japanese government bond (JGB) market has entered uncharted territory in 2025, with 10-year yields surging to 2.14% in post-holiday trade-a level not seen since 1999. This dramatic shift, driven by political uncertainty, fiscal expansion, and the Bank of Japan's (BOJ) gradual normalization of monetary policy, has reignited global concerns about the risks of yen repatriation and its cascading effects on equity and bond markets. As Japan's bond yields climb toward 2.2–2.3% of their "fair value" range, the implications for global capital flows are becoming increasingly pronounced.

The Drivers of Rising JGB Yields

The surge in JGB yields is rooted in a confluence of factors. Prime Minister Sanae Takaichi's push for expansionary fiscal policies, including a record ¥122.3 trillion budget for 2026, has heightened concerns about Japan's fiscal sustainability. With a debt-to-GDP ratio exceeding 230%, the market is pricing in the risk of higher borrowing costs. Meanwhile, the BOJ's phased exit from yield curve control-a policy that had suppressed yields for decades-has allowed market forces to dictate pricing. By December 2025, the BOJ had raised its benchmark interest rate to 0.75%, the highest since 1995, signaling a structural shift in Japan's monetary framework.

This normalization has also been fueled by persistent inflation, which has exceeded the BOJ's 2% target for over a year. Rising wage growth and modest economic activity have further supported the case for higher rates, marking what some analysts describe as Japan's emergence from post-bubble stagnation. However, the transition is not without turbulence. Japan's bond market is grappling with a supply shock, as reduced BOJ purchases and aggressive fiscal stimulus have pushed net supply to its highest level in over a decade.

Yen Repatriation and Global Market Reactions

The rise in JGB yields has triggered a reassessment of the yen carry trade-a long-standing mechanism where investors borrowed low-yield yen to fund higher-yielding foreign assets. As Japanese yields climb, the arbitrage opportunity has narrowed, prompting capital repatriation. Japanese institutional investors, including life insurers and pension funds, have begun shifting massive portfolios back into domestic debt, reducing their exposure to U.S. Treasuries and European bonds. This shift has removed a key source of global liquidity, contributing to a "bear steepening" of the U.S. yield curve.

The impact on global equity markets has been particularly acute. In November 2025, the S&P 500 and Nasdaq experienced sharp declines as leveraged investors were forced to sell high-growth tech stocks to cover yen-denominated debts. The "Magnificent Seven" tech stocks, which had been central to the AI-driven bull market, saw significant selloffs as the unwind of the carry trade accelerated. This dynamic underscores the interconnectedness of global markets, where Japan's policy shifts can directly influence asset valuations in distant regions.

Emerging markets, which have historically relied on cheap yen-based financing, are also under pressure. Indonesia, for instance, faces immediate challenges as Japanese investors repatriate capital, threatening to drive up domestic borrowing costs for energy and manufacturing sectors with significant yen-denominated debt. Similarly, Brazil and other emerging economies have historically faced vulnerabilities during yen carry trade unwinds, as highlighted by the broader global impacts of such shifts.

European Bonds and the Carry Trade Unwind

European bond markets are not immune to these dynamics. As Japanese investors repatriate capital, demand for foreign assets has waned, exerting upward pressure on yields. The European Central Bank (ECB) may face additional pressure to cut rates in 2026, given undershooting inflation expectations and decelerating wage growth. However, the normalization of Japan's monetary policy represents a structural shift in global liquidity, with implications for the cost of capital and asset valuations worldwide.

The risk of a disorderly unwind remains a critical concern. Historical precedents, such as the 2024 selloff triggered by the end of Japan's negative interest rate regime, highlight the potential for sharp yen appreciation and liquidity tightening. If the yen continues to strengthen- potentially reaching a fair value range of 152–157 against the dollar-it could further erode the returns from the carry trade and exacerbate capital repatriation.

Conclusion: Navigating the New Normal

While the risks of a disorderly JGB yield surge are real, most analyses suggest an orderly normalization path is more likely, with yields stabilizing around 2–2.5% without triggering a broader financial crisis. For investors, the key lies in adapting to the new reality of higher Japanese yields and reduced global liquidity. Emerging markets must diversify funding sources, while European bond markets may see increased volatility as demand shifts.

The unwinding of the yen carry trade is not merely a Japanese phenomenon-it is a global recalibration of risk and return. As Japan's bond market redefines its role in the global financial system, the implications for equity and bond markets will remain a central theme in 2026 and beyond.