For the first time since 1996! Japan's benchmark bond yield surpasses 3%

Japan's 10-year government bond yield broke above the 3% mark on Tuesday, reaching a nearly 30-year high and marking a historic turning point for Japan's bond market. Analysts believe this milestone is both part of the global bond sell-off and reflects public pressure from the U.S. Treasury Secretary for Japan to raise interest rates, as well as high market expectations for the Bank of Japan's policy moves in September.

According to reports by Japan's national broadcaster NHK, U.S. Treasury Secretary Scott Bessent met with Japanese Finance Minister Satsuki Katayama and Bank of Japan Governor Kazuo Ueda separately on Monday during the G20 finance ministers meeting.

Bessent made it clear to both parties that Japan should raise interest rates next. He then said in an interview with CNBC, "I have information that the market does not know, and I believe the Japanese government and the Bank of Japan will take action to strengthen the yen." This is so far the clearest signal from Washington regarding Japan's monetary policy.

The 10-year Japanese government bond yield hit 3% on Tuesday, for the first time since 1996. The 40-year Japanese government bond yield rose 6.5 basis points to 4.265%, while the 30-year yield climbed 5.5 basis points to 4.185%. At the same time, the U.S. 10-year Treasury yield also reached its highest level since January 2025, and renewed tensions in the Middle East further intensified the global bond market's selling pressure.

It is worth noting that just as Japan's 10-year bond yield surpassed 3%, today's 10-year Japanese government bond auction produced results better than market expectations.

U.S. Pressure to Hike Rates, Yen Predicament Raises Policy Urgency

Bessent's public statement on urging Japan to raise rates comes amid continued pressure on the yen's exchange rate.

Although the U.S. and Japan conducted joint foreign exchange market interventions in the past month—Japan spent a record $96.4 billion to pull the yen from a forty-year low of about 164 per dollar back up to a high of roughly 155—the yen depreciated again to around 160, erasing more than half of the intervention's effects.

According to Bloomberg, Satsuki Katayama said on Tuesday that she has confirmed with Bessent that persistent, coordinated intervention in the FX market is still necessary. "Exchange rate movements are supposed to reflect fundamentals, but often they do not," she said.

Bessent had previously noted in a public letter to senior Democratic Senator Elizabeth Warren that Japan is a major holder of U.S. treasuries, and a key U.S. partner and treaty ally.

"Disorderly yen markets could trigger forced selling, disrupt global markets, and ultimately raise borrowing costs for U.S. households and businesses," he wrote. In this context, pushing the Bank of Japan to raise rates and guide a stronger yen serves both Japan’s interests and the U.S. policy goal of lowering long-end U.S. Treasury yields.

Prior to Bessent's statements, markets had already assigned a high probability to the Bank of Japan raising rates by 25 basis points to 1.25% at its September 18 policy meeting. Bank of Japan Deputy Governor Ryozo Himino kept the possibility of a rate hike open this month during a speech last week, further reinforcing expectations.

According to Bloomberg, sources say the government led by Prime Minister Sanae Takaichi supports a near-term rate hike, with the next hike most likely in September or October.

Fiscal Pressure and Capital Repatriation Risks Cannot Be Ignored

The impact of a 3% yield surpassing goes far beyond the bond market itself.

When formulating next fiscal year's budget (starting next March), the Japanese government used an interest rate assumption of 3.8%, meaning the current yield level is already approaching the critical range of fiscal planning. Some economists and traders warn that if yields stay above 3%, there would be substantial doubts about Japan's fiscal sustainability.

At the same time, the 10-year bond yield breaking above 3% could prompt Japanese life insurance companies to sell U.S. treasuries and repatriate funds to the domestic market—a capital flow that would trigger ripple effects across global bond markets.

Japan's bond market has seen profound changes since the Bank of Japan ended the world's last negative interest rate policy in 2024. Rising yields are pushing up borrowing costs for the government, companies, and households, while significantly improving the attractiveness of domestic bonds relative to overseas assets, leading Japanese investors to reassess asset allocation.

10-Year JGB Auction Beats Expectations, but Market Split Persists

Tuesday’s 10-year Japanese government bond auction was held at the sensitive moment as yields approached 3%. The final bid-to-cover ratio was 3.29, higher than the 12-month average of 3.26, showing overall stable demand and no significant deterioration as the market had feared earlier.

This auction's outcome is notable because just last week, demand at the 2-year bond auction was notably weak. Overnight index swaps now show a roughly 90% probability for a Bank of Japan rate hike in September.

Citing earlier analysis from BNP Paribas Asset Management's senior bond strategist Ryutaro Kimura, Bloomberg noted: "If investors take a stronger wait-and-see attitude ahead of the September meeting, the 10-year bond auction could come in soft."

But he also pointed out, "Some investors see a 10-year yield of 3% as an attractive buying level and are expected to increase purchases, which should effectively prevent yields from moving significantly above 3%."

Okasan Securities strategists Naoya Hasegawa and Yuuki Kimura take a more cautious view in their research report, arguing that "last week’s weak 2-year auction result suggests underlying demand is still soft. If the 10-year auction also disappoints, upward pressure on yields above 3% will intensify."

The higher-than-average bid-to-cover at this auction partially eased the above concerns, but market disagreement over the future direction has not been resolved.

Additionally, there will be a 30-year Japanese government bond auction this Thursday, which the market is also closely watching. The Takaichi government’s fiscal stance continues to suppress demand for ultra-long bonds—Japan’s Ministry of Defense is seeking a record $56 billion defense budget for the next fiscal year, and with the government preparing to launch a new military expansion plan later this year, actual spending could be far higher.

Bloomberg strategist Mark Cranfield points out that if demand at this week's auctions falters, it could spark a global sell-off and pose a challenge to Bessent’s efforts to rein in long-term U.S. Treasury yields.