Transcription
Something remarkable is happening in Japan. The yield on a 30-year Japanese government bond just hit 4%, the highest level since the bond was launched in 1999. It has nearly doubled in the past year alone.
In fact, the gap between the 30-year Japanese government bond yield and the 30-year US bond yield is now shrinking at a very rapid pace. The moment these two lines cross, it could wreak havoc on the US bond market. This is probably the single most overlooked development happening in markets right now.
The bond market is the most powerful force in our financial system. And what happens in the US bond market directly impacts the economy and stock market. Now, Japan is by far the single biggest foreign owner of US treasuries, holding over $1.2 trillion of them. For decades, Japanese investors have been some of the most reliable buyers of American debt. But this loyalty was primarily based on the fact that American debt yielded significantly more returns than Japanese debt.
So the moment that yields in Japan start to rise above the yields in the US, those same investors suddenly have every reason to sell their US bonds and bring that money back home. If enough of them rush for the exit all at once, US bond yields will spike, which means not only will the US government need to pay more interest on its national debt, but you're also going to see things like mortgage rates rise along with this.
So, should we actually expect this to happen? And to answer that, we need to look at why Japanese bond yields were so low in the first place. If we add Japan's average inflation rate here, you can see for the most part of the last three decades, Japanese inflation was exceptionally low or the economy was in outright deflation. So, negative inflation.
But right now, we're seeing a generational shift in what's happening with inflation in Japan. This is extremely important to understand because the Japanese government carries the single heaviest debt load in the entire developed world with its debt being more than 200% the size of its economy. On paper, a debt pile this big should have led to a major debt crisis. Typically, when debt levels are too high, private investors will see government debt as being too risky and so demand for the government debt will fall. When demand falls, that makes bond yield spike, which is essentially how a debt crisis plays out.
But when inflation is low and steady, like it has been in Japan, it allows the local central bank, in this case the BOJ, to step in to replace any private investors that are no longer buying bonds in an effort to keep bond yields low. And that's exactly what they did. This is the Bank of Japan's balance sheet, and it's climbed relentlessly for more than two decades now. You see, because inflation was nowhere to be found, the Bank of Japan was essentially free to simply print money and use that to buy up its own government bonds year after year. All of that buying kept bond yields in Japan low. At its peak, the Bank of Japan actually owned more than half of all Japanese government bonds in existence.
But then something changed. If we look at the right side of this chart, we see that the central bank has had to change its ways. It has actually been reducing the size of its balance sheet quite aggressively since 2024. And this is a direct result of the higher levels of inflation that we discussed earlier. Higher levels of inflation are now forcing the Bank of Japan to stop printing money and abandon its policy of holding yields down. And lo and behold, Japanese bond yields are spiking.
In fact, real interest rates in Japan, meaning adjusted for inflation, have now officially surpassed those of the United States. Real interest rates are one of the most powerful forces in all of finance because they essentially decide where the world's money wants to live. For years, Japanese real interest rates sat below zero and much below the real interest rates in the US. The Japanese consumer earned almost nothing by keeping his money at home. And so trillions of dollars flooded out of Japan in search of better returns in the US, representing a significant chunk of demand for US Treasury bonds.
But now that Japan's real interest rate rivals America's and is now even surpassing it, Japanese investors can now earn a higher real return at home. And we're already starting to see the consequences of this. In the first 3 months of 2026, Japanese investors sold almost $30 billion worth of US bonds. So if real interest rates in Japan continue to rise, the incentive for Japanese investors to deploy capital at home instead of abroad significantly increases. This could lead to significant selling pressure on US treasuries, pushing US yields higher and so having knock-on effects on the economy and stock markets.
Now, inflation in Japan has been coming down recently, which many economists believe could make things go back to the way they were in the last 20 years. Unfortunately, we believe there is evidence that Japan's inflation could begin to turn up once again, making the situation even worse. This is the Japanese import price index, which tracks import costs in Japan. And these tend to lead the overall inflation rate in Japan by a few months and it's currently telling us that inflation in Japan may be about to turn up again.
So yes, Japanese bond yields are very likely to rise further from here and yes, it will have an impact on the US bond market. Now, while most are picturing an imminent brutal collapse of the two bond markets, the real-world results could end up being a little bit more boring than that. The impact of Japan on the US bond market has never been acute. It's always been structural. For example, low bond yields in Japan were one of the key forces that contributed to structurally low bond yields for the US in the 2010s as it made Japanese investors flock to US bonds.
Now, this era is clearly over and the result will likely be that higher bond yields in Japan will have the opposite effect and lead to structurally higher US bond yields in the coming years. Although this may not have an impact on the US immediately, structurally higher bond yields like the US experienced in the 1970s triggered a decade of stagnation both in the economy and stock markets. There are many factors that are currently pointing to structurally higher bond yields today including Japan which could lead to a similar outcome for the next decade.
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