The yield on Japan's 10-year Treasury bond reached 3% on Monday, September 1, in Tokyo, for the first time since September 1996. On the same day, the five-year rate reached a record high of 2.265% and the two-year rate rose to 1.795%, the highest level in 31 years. On the following Wednesday, the yield remained around 3.02%. The market assigns an 80% probability to an interest rate hike by the Bank of Japan at the September 17-18 meeting, to 1.25%.
For three decades, Japan was the country where the world went to get almost free money, with interest rates close to zero or even negative. This mechanism, known as carry trade, allowed investment funds to borrow yen in Tokyo, convert them into dollars and invest them in US bonds, tech stocks or cryptocurrencies, profiting from the interest rate differential. Now, this silent fuel of global markets is disappearing, in a context of Middle East crisis that fuels fears of global inflation.
Japan is the most indebted country in the developed world, with public debt equivalent to 204% of GDP. The budget for 2026 amounts to 122.3 trillion yen, of which 31.3 trillion will be destined for debt service, meaning about one in every four yen raised will be used to pay off its own debt. The Ministry of Finance is already considering raising the interest rate assumption to 3.8% in the 2027 budget. Paradoxically, despite the rate increases, the yen remains weak, with the dollar-yen pair hitting 159.7 on September 1, a 7.5% depreciation since the beginning of the year.
Japan is also the largest foreign holder of US debt, with approximately 1.2 trillion dollars. In the first quarter of 2026, Japanese investors sold 29.6 billion dollars in US bonds, the largest quarterly outflow since 2022, at a time when investing in the domestic market may already compensate without the currency risk. The US Treasury Secretary, Scott Bessent, has asked Japanese authorities to present a clear path for fiscal sustainability, in a shift of emphasis from currency intervention to monetary and fiscal policy measures.
