Japan Warns Of Bond Market Risk As BOJ Slows Buying

Japan’s government has issued an unusual warning about rising long-term government bond yields and the changing structure of debt ownership. The alert comes as part of the country’s newly approved annual economic and fiscal policy roadmap, which will guide the next budget cycle.

The warning follows recent turmoil in Japan’s bond markets, where yields on super-long Japanese Government Bonds (JGBs) briefly hit record highs. This spike was driven by three key factors: the Bank of Japan (BOJ) reducing its bond purchases, declining demand from life insurers, and growing concern over Japan’s worsening fiscal health.

BOJ’s Exit from Bond Market Creates New Risks

The BOJ currently holds about 46% of all JGBs. However, the central bank has been tapering its massive bond-buying program, signaling a slow shift away from aggressive monetary easing. While no major changes to the tapering plan are expected at next week’s BOJ meeting, officials may consider reducing the pace of tapering next fiscal year to prevent market shocks.

As the BOJ pulls back, the government is placing more responsibility on domestic private-sector banks to help stabilize the bond market. But these banks face restrictions due to capital requirements, which limit their ability to hold long-duration assets like government bonds.

Foreign investors have also increased their share of JGB holdings over the past decade. However, analysts warn this is risky. According to Koichi Sugisaki, macro strategist at Morgan Stanley MUFG Securities, foreign investors typically have shorter holding periods than traditional domestic buyers like life insurers. He described the situation as “like magma ready to erupt”—warning that a sudden shift in sentiment could trigger major volatility.

Breakdown of JGB Ownership (as of end-2024):

BOJ: 46%

Banks: 14.5%

Insurance companies: 15.6%

Foreign investors: 11.9%

Government Responds with New Bond Strategies

To mitigate risks and attract more stable buyers, the Japanese government is planning several key initiatives:

Issuing floating-rate JGBs tied to short-term interest rates to reduce risk from rising yields.

Expanding access to retail-targeted JGBs, allowing non-profits and unlisted companies to invest.

Buying back older super-long bonds issued at low interest rates to rebalance supply and demand.

Cutting future issuance of super-long bonds to relieve market pressure.

These steps are designed to promote greater domestic ownership of bonds, which the government says is crucial to avoid sudden surges in long-term interest rates caused by supply-demand imbalances.

Political Pressure and Fiscal Outlook

Japan’s bond market also faces pressure from political developments. Calls from opposition parties for tax breaks to ease the burden of inflation are mounting. However, Prime Minister Shigeru Ishiba has so far resisted these demands. Instead, he has directed his party to offer cash handouts during the campaign for the upcoming July upper house elections—avoiding new borrowing through deficit-financing bonds.

At the same time, the government has quietly delayed its long-standing goal of achieving a primary budget surplus. Originally set for fiscal 2025, the new target is now “as early as possible during fiscal years 2025 to 2026.”

Global Markets React

The concerns surrounding Japan’s bond market, combined with global economic uncertainty, weighed heavily on markets Friday:

Dow Jones fell by 1.8%

S&P 500 declined by over 1%

Nasdaq dropped 1.3%

Conclusion

Japan’s rare bond market warning marks a significant shift in fiscal strategy, as the government adapts to a new financial reality without the heavy support of the BOJ. While policymakers seek to stabilize the bond market with new tools and targeted changes, the road ahead is filled with risks—both economic and political.