After 30 years, Japan’s 10-year government bond yield returns to 3%, breaking the major shackles of the “zero interest rate era”

According to Zhicheng Finance APP, Japan’s 10-year government bond yield briefly rose to 3% on Tuesday, marking the first time it has reached this level since the beginning of the 21st century. This is a key milestone in the normalization process for the country’s bond market, after years of benchmark borrowing costs hovering near zero. The yield climbed by 6 basis points on the day, hitting the 3% mark—the highest since 1996. A year ago, the yield was just half of its current level, highlighting the rapid change with effects now spreading across Japan’s economy and the global financial markets.

Since the Bank of Japan ended the world’s last negative interest rate policy in 2024, the fundamental logic of the country’s bond market has shifted. Previously, government bonds were largely controlled by central bank price management. Now, domestic and foreign investors are more independently driving trading decisions—basing their actions on inflation and growth prospects and the relative risk-return of Japanese bonds compared to other assets, rather than strictly following central bank guidance.

“Rising yields will pressure existing investment portfolios with mark-to-market losses, but at the same time, they create more attractive entry points for fixed income investors,” said Wee Khoon Chong, Senior Market Strategist for Asia Pacific at BNY Mellon. “Japanese government bonds are once again becoming a credible allocation option.”

Although the Bank of Japan still holds a large portion of the country’s government bonds, the rise in yields is encouraging more domestic institutions to increase their holdings, while global funds are becoming increasingly active in this market. International investors now account for about two-thirds of the monthly spot Japanese government bond trading volume, significantly up from 12% in 2009.

This change coincides with a global rise in bond yields—higher oil prices have intensified inflation concerns, and expectations of a US Federal Reserve rate hike continue to build, increasing volatility in the Japanese market. The Bloomberg Global Sovereign Bond Yield Index rose for the fourth straight trading day on Monday, reaching 3.72%, its highest since mid-2008.

The rise in Japanese government bond yields also reflects the country’s once-stagnant economy entering a full-scale reflation, with corporate profits surging and wages rising in tandem. For the Japanese government, the challenge is to ensure that economic growth translates into sufficient tax revenues to cover rising funding costs due to higher yields. Against this backdrop, the Ministry of Finance has budgeted a record 36.6 trillion yen (approximately $230 billion) for debt servicing costs in its preliminary request for the next fiscal year.

The 10-year government bond yield fell slightly after an auction of bonds with the same maturity on the day, as auction demand was roughly in line with the 12-month average.

As investors increasingly bet that the Bank of Japan will raise rates again soon—possibly this month or next—yields have risen across all maturities. Prime Minister Sanae Takaichi’s government reportedly supports a near-term rate hike to address the continuing weakness of the yen. US Treasury Secretary Scott Besent has also pressured the Bank of Japan, urging further monetary policy action.

Overnight index swap data shows the market is pricing a roughly 92% probability of the Bank of Japan hiking rates before September, with a hike in October already fully priced in.

Concerns over fiscal sustainability are also reflected in the rising yields. Sanae Takaichi has announced an unprecedented spending plan aimed at reshaping Japan’s economy, but the government has yet to clarify how it will fund the cut to the food consumption tax. As yields climb, investors are becoming increasingly sensitive to the government’s potential for further borrowing.

“While some bond investors may now find current levels attractive and have started buying, more participants are still betting that yields will continue to climb,” said Hiroshi Namioka, Chief Strategist at T&D Asset Management. “Additionally, fiscal concerns could trigger further yen weakness, so in my view, a meaningful return of funds will still take some time.”