Japan’s Inflation and Yield Shift Signal Global Policy Divergence
Japan’s inflation outpaces peers, prompting rate hikes. Global 30-year yields rise amid fiscal concerns, weak bond demand, and shifting capital flows, signaling a broader shift in monetary policy and investor sentiment.
After decades of subdued inflation, Japan is now experiencing persistently elevated price levels, hovering near post-COVID highs. Currently, inflation in Japan exceeds that of other developed markets. In contrast, inflation in the US and Eurozone has moderated from previous peaks and is trending toward more typical levels. While most other developed market central banks are on the path of lowering policy rates, higher inflation is putting Japan on the opposite path, prompting a shift toward increasing policy rates.
Weekly Highlights
Global Interest Rates: A Broader Story Beyond the US
Last week, we discussed the Moody’s downgrade of U.S. debt and noted how both equity and bond markets showed a relatively muted initial reaction. While the downgrade had been largely anticipated, it’s part of a broader and more persistent trend: the steady rise in global long-term interest rates.
Much of the market’s attention naturally gravitates toward the U.S., given the size and influence of its debt market. However, this is not just a US phenomenon. Across the globe, long-term interest rates have been climbing, driven by similar underlying forces.
One of the key drivers is the growing concern around fiscal spending and the sustainability of debt levels. As governments continue to run large deficits, investors are demanding higher yields to compensate for the increased risk. This is especially true in an environment where protectionist policies are gaining traction. As countries become more self-reliant, they may need to ramp up spending in areas like defense or provide economic support from the effects of declining exports. These shifts add to fiscal burdens and contribute to the upward pressure on yields.
Another factor is the heightened uncertainty about the long-term economic outlook. In such an environment, investors typically require higher returns to justify locking in capital for extended periods. This risk premium is now being reflected in global bond markets.
Japan offers a particularly interesting case study. Japanese 30-year government bond yields recently hit 25-year highs. This move was partly triggered by weak demand in recent auctions of newly issued long-term debt, suggesting a potential supply-demand imbalance. There may simply be less investor appetite for ultra-long-dated bonds, which could prompt a reassessment of issuance strategies going forward.
But Japan’s story doesn’t end there. Inflation has remained in the mid-to-upper 3% range—levels not seen in decades. In response, the Bank of Japan has begun to unwind its ultra-loose monetary policy. After maintaining negative interest rates since 2016, the central bank started raising its policy rate in 2024, bringing it to levels not seen since before the Global Financial Crisis.
In August 2024, Japanese equities experienced a sharp drawdown of -25% (in local terms), driven by the unwinding of the yen carry trade. For years, investors had borrowed at low Japanese rates to invest in higher-yielding assets abroad. As Japanese rates rose, the economics of that trade deteriorated, prompting a wave of repositioning.
Looking ahead, if Japanese yields continue to rise, domestic bonds may become more attractive in their own right—potentially reducing the incentive for capital to flow overseas. This could have ripple effects across global markets, especially in sectors and regions that have historically benefited from Japanese capital outflows.
Go beyond the headlines...
Skimmed the summary? Dive deeper with the full PDF—your go-to for weekly market insights and analysis.