Japanese government bonds extended losses on Monday as markets speculated the Bank of Japan may need more aggressive rate hikes to counter persistent yen weakness. The benchmark 10-year JGB yield surged 7.5 basis points to 2.095%, marking its highest level since February 1999, while the policy-sensitive 2-year yield rose 3 basis points to 1.12%, a peak unseen since 1997.
The BOJ delivered a widely anticipated 25-basis-point rate hike last Friday, lifting its benchmark rate to 0.75% - the highest in three decades. However, the yen weakened as traders expressed disappointment over the central bank's failure to provide clear guidance on future tightening. The USD/JPY pair stood at 157.34 at press time, with the yen recouping some losses after Japanese officials warned against excessive currency volatility.
Finance Minister Satsuki Katayama and top currency diplomat Atsushi Mimura voiced concerns about the yen's slide post-BOJ decision. Mimura stated: "We're deeply concerned about the one-sided, abrupt moves following last week's policy meeting and will respond appropriately to excessive volatility."
"The yen's sharp depreciation is seen as a key driver pushing JGB yields higher, as it fuels speculation about earlier-than-expected rate hikes," said Keisuke Tsuruta, senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities. He added that yields would likely remain elevated given post-meeting market conditions and lingering fiscal concerns.
Overnight index swaps now fully price in the next BOJ rate hike by July 2025, compared with September 2025 expectations last Friday. Ryutaro Kimura, senior fixed income strategist at AXA Investment Managers, noted yen weakness ranks among Tokyo's top concerns, with investors anticipating Prime Minister Sanae Takaichi - known for monetary easing advocacy - may permit further tightening to support the currency, "accelerating JGB yield curve flattening."
Notably, the 10-year yield's sharper rise versus 2-year bonds partly reflects market anxiety about Japan's FY2026 (ending March 2027) budget and debt issuance plans. The cabinet will finalize the FY2026 budget this Friday alongside JGB issuance details, with growing concerns over potential increases in 10-year bond supply to cover fiscal gaps.
Fiscal Expansion Deepens Debt Concerns Japan's parliament approved an ¥18.3 trillion ($116 billion) supplementary budget for FY2025 on December 16 - the largest post-pandemic stimulus - with over 60% funded by new debt issuance. This raises concerns that BOJ rate hikes will directly increase government borrowing costs, exacerbating Japan's already strained finances.
Rising short- and long-term yields threaten to balloon Japan's debt servicing burden, with the finance ministry projecting 10-year yields could reach 2.5% by 2028. Interest payments may double from ¥7.9 trillion in 2023 to ¥16.1 trillion by 2028. IMF data shows Japan's debt-to-GDP ratio will hit 229.6% in 2025 - the highest among developed nations.
Prime Minister Takaichi's expansionary policies have sparked sustainability concerns as she balances inflation control with investor confidence. To demonstrate fiscal responsibility, Takaichi pledged to keep this year's total bond issuance below last year's ¥42.1 trillion level. Including new ¥11.7 trillion debt, FY2024 issuance will total ¥40.3 trillion, down 4.3% year-on-year.
The stimulus package also draws on ¥2.9 trillion in higher-than-expected tax revenue, ¥2.7 trillion in unused FY2023 funds, and ¥1 trillion non-tax income. However, continued massive debt issuance amid rising rates risks worsening Japan's fiscal position, with experts warning unchecked expansion could trigger sustained yield spikes, further yen depreciation, and financial market turmoil.