Recently, Japan’s bond market has experienced periods of sudden highs and lows, with capital flowing in and out in waves. This situation, which echoes the multiple “stock-bond-currency triple threats” in the U.S., has garnered global attention. On August 5th last year, there was a global financial event when the Nikkei index plummeted and yen futures were liquidated. It is evident that Japan has shifted from benefiting from the “frontier dividends” of President Biden’s policies to standing at the “risk frontier” under President Trump.
In April, in the wake of Trump’s “reciprocal tariffs” policy, safe-haven capital flooded into Japan’s equity and bond markets, with net purchases exceeding ¥8.21 trillion, of which ¥4.54 trillion was invested in mid- to long-term Japanese government bonds—this being the highest level since 2005. However, in less than a month, there was a dramatic reversal, with interest in Japanese bonds plummeting. On May 20th, Japan’s 20-year government bond auction saw the worst performance in 38 years, with the bid-to-cover ratio falling to 2.5 (compared to 2.96 in the last auction), and the “tail” difference, a gauge of bidding success, rising to ¥1.14 (up from ¥0.34 in the previous auction). As a result, the secondary market saw a significant sell-off, with the yields on 10-year, 30-year, and 40-year bonds all rising sharply, signaling a price drop and leading some to label the situation as “disastrous.” On May 28th, the 40-year bond auction remained weak, with the bid-to-cover ratio falling to 2.21 (from 2.92 in the last auction), the lowest in 13 years. The highest accepted yield rose to 3.135%, higher than the predicted range of 3.07% to 3.11%, but lower than the secondary market’s historical high of 3.675% on May 22, indicating weak investor demand, though not yet sufficient to trigger a global collapse. Former Ministry of Finance official, and a participant in the Plaza Accord negotiations, Haruo Okuda, warned that “Japan’s sovereign debt rating is gradually deteriorating, and the market may experience a sudden shift one day.”
Behind the turmoil in Japan’s bond market lies a combination of risks caused by Japan’s economic slowdown, the exit from Quantitative and Qualitative Easing (QQE), and the fiscal mismanagement in Western countries, leading to “shocks” and “confidence shifts.”
1. Japan’s Economic Data Shows Signs of Weakness
Japan’s latest economic data has raised concerns. In the first quarter of 2025, the GDP contracted by 0.2% quarter-on-quarter, a 0.7% annualized decline, marking the first negative growth in a year. Personal consumption and external demand remained sluggish, with real wages declining for the third consecutive year, and personal consumption showing minimal growth. Exports also fell by 0.6% quarter-on-quarter. The price of essential goods such as rice surged to twice last year’s price, signaling major political and economic risks. Additionally, after Japan’s GDP was overtaken by Germany in 2024, Japan’s position as the world’s largest creditor nation, held for 34 years, was also lost to Germany. Many are worried that the U.S.’s “reciprocal tariffs” could disrupt global supply chains, leading to economic contraction, spiraling inflation, and financial disorder.
2. The Bank of Japan’s Exit from QQE and Reduced Bond Purchases
The Bank of Japan, under the leadership of Prime Minister Kishida and former Finance Minister Ishiba, has been gradually advocating for a return to normal interest rates to curb inflation and promote structural reforms. As part of this shift, the BoJ began reducing its bond purchases starting from Q3 of 2024, aiming to decrease its bond-buying at a pace of ¥0.4 trillion per quarter, bringing the purchases down to ¥3 trillion by Q1 of 2026. The market expects this trend to continue, with purchases dropping to ¥2 trillion by Q1 of 2027. As of now, the BoJ’s balance sheet has shrunk by ¥21 trillion from the historical peak in November 2023, with the nominal losses on government bonds reaching ¥28.62 trillion. Given that the BoJ is the largest holder of Japanese government bonds (over 50%), this reduction in purchases is expected to significantly affect the supply-demand balance in the bond market, keeping yields high (prices low). This creates a dilemma for Ishiba, who faces rising financing costs (higher interest payments) while trying to maintain fiscal discipline (less issuance of debt). Faced with rising prices, deteriorating fiscal conditions, weak external demand, and declining internal demand, Japan’s gradual exit from QQE could lead to a “hard landing” for its financial system.
3. Deteriorating Fiscal Conditions in Western Countries
As of March 2025, global debt has ballooned to a record high of $324 trillion. In the U.S., Trump’s “Tax Cuts and Jobs Act” has passed the House and is under review in the Senate. It is widely anticipated that the U.S. fiscal deficit will balloon by $3-5 trillion over the next decade, with no clear solutions to offset it through “reciprocal tariffs” or “spending cuts.” In Europe, Germany, the largest economy, plans to increase spending by €1 trillion over the next decade for defense and infrastructure. This is expected to increase government debt by 50%. Fitch has warned that if this increase does not lead to sustainable economic growth, Germany’s credit rating could come under long-term pressure. In Japan, government debt has reached 235% of GDP, with discussions about reducing consumption tax becoming a central political issue. Ishiba publicly responded to opposition calls for “tax cuts,” saying, “Japan’s fiscal situation is very poor, worse than Greece.” The market has become aware of the potential fiscal risks facing Western countries, and rising yields on bonds, including Japan’s, are seen as a warning sign.
Japan’s financial system is part of the global dollar-based order, and the “frontier risks” it faces are part of the broader disruption to the global financial system in the era of the dollar’s diminishing dominance. From the collapse of the Bretton Woods system to the Plaza Accord and the so-called “Mar-a-Lago Agreement,” the U.S. has yet to solve its “twin deficits” or “Triffin dilemma,” and the world remains in search of a new order. Facing the dollar’s difficulties, the U.S. has shifted to having its allies bear more of the burden, but “monetary chaos does not create order.” Japan’s financial system will likely rely on the highly developed production and supply chains and seamless financial flows of East Asia to regain trust and credibility in the new world order.