Japan’s Bond Market Turmoil: 40-Year Yields Hit Record 4% Amid Fiscal Policy Concerns

Japan’s government bond market experienced unprecedented turmoil on Tuesday as yields on 40-year government bonds surged to a historic 4%, marking the highest level since the maturity was introduced in 2007 and representing a watershed moment for the world’s most indebted developed economy.

The dramatic spike in long-dated bond yields came just one day after Prime Minister Sanae Takaichi announced her plans to dissolve parliament on Friday and call a snap election for February 8, setting the stage for a campaign expected to center heavily on economic policy and fiscal management. The timing of the bond market selloff has intensified concerns about Japan’s ability to manage its massive public debt burden while pursuing expansionary economic policies.

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Historic Yield Movements Across the Curve

The 40-year government bond yield’s climb above the 4% threshold represents more than just a numerical milestone—it signals a fundamental shift in investor sentiment toward Japanese sovereign debt. According to Bloomberg reports, the long-dated yield jumped more than 5.5 basis points to breach this critical level, driven by mounting concerns over the fiscal implications of Takaichi’s proposed policies.

The selloff wasn’t confined to ultra-long maturities. Yields across the entire curve experienced sharp increases, with the 10-year Japanese government bond yield rising by over 6 basis points to 2.3%, reaching its highest level since 1999. This marks a particularly significant development, as the 10-year yield had remained below 2% for most of the past two decades, aside from a brief spike to 2.005% in May 2006.

Meanwhile, the 20-year tenor experienced even more pronounced pressure, with yields jumping approximately 9 basis points to 3.35%. The 30-year bond yield also climbed substantially, surpassing Germany’s corresponding rate of around 3.5%—a remarkable reversal for a market that had long been characterized by yields well below those of global peers.

The Food Sales Tax Controversy

At the heart of the market turbulence lies Takaichi’s controversial proposal to suspend the 8% consumption tax on food for two years—a policy shift that represents a dramatic departure from her Liberal Democratic Party’s longstanding fiscal conservatism. The LDP has historically resisted opposition calls for consumption tax cuts, arguing that such measures would erode market confidence in Japan’s fiscal discipline.

According to government data cited in multiple reports, scrapping the 8% food sales levy would reduce government revenue by an estimated 5 trillion yen ($31.71 billion) annually—roughly equivalent to Japan’s annual education expenditure. This massive revenue gap has sparked intense debate among economists and market participants about how the shortfall would be financed.

Keiji Kanda, a senior economist at the Daiwa Institute of Research, expressed skepticism about the policy’s rationale: “I can’t see why Japan needs a consumption tax cut after compiling a significant stimulus package to counter rising inflation. I’m worried these steps could accelerate inflation and lead to further rises in bond yields.”

The proposed tax cut comes as Japan levies an 8% consumption tax on food and a 10% levy on other goods and services, revenue streams that help fund rising social welfare costs for the nation’s rapidly aging population. Takaichi has stated that the government will not issue debt to fund the suspension, suggesting instead that measures could include a review of existing subsidies.

The Return of the “Takaichi Trade”

Market analysts have characterized the current volatility as a revival of what has become known as the “Takaichi trade”—a pattern of simultaneous stock market gains, bond selloffs, and yen weakness driven by expectations of expansionary fiscal policy under Takaichi’s leadership.

Masahiko Loo, senior fixed income strategist at State Street Investment Management, explained the dynamics: “Ultra-long JGB yields are being pushed higher not only by the structural supply-demand imbalance but also by a fresh re-pricing of term and risk premium as markets absorb a more expansionary fiscal stance and persistent inflation.”

Loo added that this has revived the classic Takaichi trade dynamic of stronger Nikkei, weaker JGBs and yen—a pattern that first emerged in October 2025 when Takaichi took office. At that time, Japanese markets reacted strongly to her policy signals pointing toward looser fiscal policy, though the volatility later stabilized.

Importantly, Loo emphasized that the current move has strong technical and sentiment echoes rather than signaling structural distress. He projected that the yield curve is likely to remain steep through the first half of 2026 before stabilizing as bond issuance patterns adjust and domestic banks return as buyers.

Japan’s Precarious Fiscal Position

The bond market’s reaction must be understood in the context of Japan’s already precarious fiscal situation. Japan’s government debt currently stands at approximately 237% of GDP, the highest among advanced economies and a figure that has long raised concerns about fiscal sustainability.

Under Takaichi’s administration, the government has compiled a record $783 billion budget for the next fiscal year, on top of a massive stimulus package focused on easing the pain of rising living costs. This expansionary fiscal stance comes at a time when the country faces mounting pressures from an aging population, with spending on health and long-term care expected to rise substantially in coming decades.

Analysts at Crédit Agricole Corporate and Investment Bank noted that markets are increasingly pricing in a durable shift toward aggressive fiscal policy under Takaichi. This stance, which aims to move away from what Takaichi has described as the “shackles of excessive austerity,” could translate into larger deficits and further strain on the nation’s already stretched finances.

Political Dynamics and Opposition Response

The election announcement has created a complex political landscape, with opposition parties also embracing the idea of consumption tax cuts—though with differing approaches. The newly formed Centrist Reform Alliance, created through a merger between the Constitutional Democratic Party and Komeito, has proposed permanently eliminating the food sales tax by generating necessary financing through managing a new sovereign wealth fund.

This creates an unusual situation where both the ruling coalition and the main opposition are campaigning on similar sales-tax platforms, differing mainly on whether the cuts should be temporary or permanent. The Constitutional Democratic Party believes a sales tax cut could be achieved as quickly as six months after passing the necessary legislation, with funding initially coming from reserve funds.

Takaichi appears to be banking on her high personal approval ratings—which have at times touched 80%—to consolidate her grip over the lower house of parliament, where the ruling bloc currently holds only a slim majority. A victory in the upcoming election would give Takaichi a public mandate to pursue her expansionary fiscal policies more aggressively.

Market Implications and Investor Concerns

The sharp rise in yields has made Japan’s bond market increasingly attractive for foreign investors, who now account for roughly 65% of monthly cash JGB transactions, according to Japan Securities Dealers Association data. The 40-year yield above 4%—significantly higher than comparable German bunds—offers increasingly attractive value for both domestic and foreign long-term holders, especially on a currency-hedged basis where yield pickup is substantial.

However, this foreign interest comes with its own risks. Yuuki Fukumoto, senior financial researcher at NLI Research Institute, warned: “There is no clear funding source for the consumption tax cut, and markets expect it to be financed through government bond issuance.” This expectation has contributed to the sustained selling pressure across the yield curve.

The broader market reaction extended beyond bonds. Japanese equity markets showed resilience, with the Nikkei 225 posting gains as investors bet that fiscal expansion would support corporate earnings. Food-related stocks saw particular strength, with Yamazaki Baking Co shares rising as much as 7.4% and Seven & i Holdings gaining 5% on expectations that lower taxes would boost consumer demand.

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Historical Context and Deflation’s End

The current yield environment represents a dramatic shift from Japan’s decades-long struggle with deflation. Following the burst of the “bubble economy” in the early 1990s, the 10-year JGB yield fell below 2% in 1999 and remained largely below that threshold for over two decades. The country experienced seven consecutive years of deflation starting in 1999, followed by decades of economic stagnation.

It wasn’t until the global inflation shock triggered by the COVID-19 pandemic that Japan began to shake off its deep-rooted deflationary mindset. Now, gains in consumer prices are running around 3% and have exceeded the Bank of Japan’s 2% target for more than three consecutive years. Data shows that inflation has remained above the central bank’s target for 41 consecutive months.

Bank of Japan’s Balancing Act

The fiscal expansion is occurring alongside the Bank of Japan’s gradual normalization of monetary policy. The central bank has been carefully unwinding decades of ultra-loose monetary policy, having raised its policy rate to 0.75% in December 2025—the highest level in three decades. BOJ Governor Kazuo Ueda has repeatedly stated that the bank stands ready to raise rates further if economic and price developments align with projections.

This creates a policy paradox: the simultaneous loosening of fiscal restraint and tightening of monetary conditions. While this combination may seem contradictory, it reflects Japan’s current struggle with rising living costs, particularly for food and energy, which has been exacerbated by a persistently weak yen.

The weak yen has been a particular point of contention. Finance Minister Satsuki Katayama indicated in discussions with U.S. Treasury Secretary Scott Bessent that both countries share concerns about “one-sided yen moves.” The currency has weakened to levels that previously triggered government intervention, trading near 159 per dollar—close to thresholds that prompted action in 2024.

Auction Dynamics and Supply Concerns

The bond market’s stress has been exacerbated by concerns about the supply-demand balance. A lackluster auction of 20-year bonds earlier in the week underscored broader worries about government spending and inflation. Market participants have been adopting tactical approaches, selling longer-dated bonds to secure more favorable pricing at upcoming auctions for 20-year, 30-year, and 40-year bonds.

Japan’s primary dealers have indicated that more issuance of two-, five-, and 10-year government bonds would be desirable for the next fiscal year starting April 1, while calling for a reduction in sales of super-long debt. This recommendation aligns with reported government plans to cut super-long bond issuance, providing some market relief amid concerns about debt sustainability.

Long-Term Sustainability Questions

The fundamental question facing Japan is whether the current fiscal path is sustainable. Hideo Kumano, economist at Dai-Ichi Life Research Institute, summarized the challenge: “The Takaichi administration is taking risks regarding fiscal discipline.”

Various analyses paint different pictures of Japan’s fiscal trajectory. Under baseline scenarios from the Cabinet Office, the debt-to-GDP ratio was projected to reach around 199% by 2033, though this assumed continuation of past trends without major policy shifts. The more optimistic scenarios assumed higher productivity growth and increased labor force participation, which could help stabilize the debt ratio.

However, these projections were made before Takaichi’s more aggressive fiscal expansion plans. The International Monetary Fund has warned that Japan’s fiscal deficit could increase further given political demands on the minority government, and that any expansionary measures should be offset by higher revenues or expenditure savings elsewhere in the budget.

As interest rates rise, the cost of servicing Japan’s large public debt is expected to double by 2030, putting a premium on a robust debt management strategy. The government will need to rely increasingly on demand from foreign investors and domestic institutions as the Bank of Japan continues to shrink its balance sheet.

Expert Perspectives on Market Outlook

Despite the near-term volatility, some analysts maintain that the situation doesn’t represent a systemic crisis. The emphasis from multiple market observers is on the technical and sentiment-driven nature of the current moves rather than fundamental breakdown in Japan’s fiscal framework.

Thomas Mathews, head of Asia-Pacific markets at Capital Economics, suggested that fiscal stimulus could eventually support the yen: “Hiking will be hard to avoid if she does fiscal stimulus and the economy starts running hot. That could trigger a sharp rebound in the yen next year.”

However, the path forward remains fraught with uncertainty. Investors are on guard for potential spillover effects into global markets amid the prospect of continued volatility in Tokyo trading ahead of the February 8 snap election. The outcome of that vote will likely determine whether Takaichi’s fiscal expansion plans proceed as envisioned or face political constraints.

Food Inflation and Consumer Pressures

The context for the consumption tax debate is Japan’s persistent food price inflation. Soaring food costs have been a key component driving broader inflation higher, with data showing that the proportion of food spending within overall household consumption reached 28.9% in November—the highest for that month since comparable data became available in 2000.

Voter frustration over the cost of living was a major factor in setbacks for the LDP in the last two national elections, creating strong political incentives for both ruling and opposition parties to address the issue through tax cuts. Takaichi has positioned the two-year food tax suspension as a measure to “cushion the blow to households from rising living costs,” framing it as a temporary relief measure rather than a permanent fiscal commitment.

International Comparisons

Japan’s situation stands in stark contrast to other developed economies. While many countries have seen their debt levels rise in recent years, Japan’s debt-to-GDP ratio remains in a category by itself. The nation’s 30-year bond yield now exceeds Germany’s equivalent rate, a reversal of the long-standing pattern where Japanese yields traded well below those of European peers.

This convergence reflects both the normalization of Japan’s previously ultra-low rates and growing market concerns about the sustainability of its fiscal position. The fact that over 80% of Japan’s debt consists of medium- to long-term instruments with an average maturity of 9.5 years provides some cushion against rapidly rising interest costs, but also means that refinancing needs will remain substantial for years to come.

Looking Ahead

As Japan heads toward its February 8 election, the bond market will continue to scrutinize every policy pronouncement and economic data release for signals about the country’s fiscal future. The combination of record-high yields, a weak currency, and elevated stock prices creates a unique and potentially unstable configuration that will test policymakers’ ability to manage competing economic and political pressures.

Takaichi’s challenge will be to demonstrate that her vision of “responsible and proactive public finances”—a phrase she has used repeatedly to describe her approach—can deliver economic growth without triggering a crisis of confidence in Japanese government debt. With the world watching and markets on edge, the coming weeks will be crucial in determining whether Japan can successfully navigate its transition away from decades of deflation without sacrificing fiscal sustainability.

The stakes extend beyond Japan’s borders. As one of the world’s largest economies and a major holder of foreign assets, instability in Japanese financial markets could have ripple effects across global bond and currency markets. For now, analysts are treating the recent volatility as a repricing rather than a crisis, but the situation remains fluid as the election approaches and investors continue to assess the long-term implications of Japan’s shifting policy landscape.

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By: Montel Kamau

Serrari Financial Analyst

20th January, 2026