Japanese Prime Minister Takaichi’s plans to boost spending and cut tax spooked bond markets on worries that Japan’s government debt will expand. The 10-year Japanese Government Bond, or JGB, yield jumped 26 basis points to 2.33% month-to-January 20, sparking broader market concerns.
10-year JGB Yields Overtake China and Singapore Government Bonds
Why It Matters: The Japanese government has benefited from low interest rates averaging around 0.33% between 2016 and 2025. With the 10-year JGB yield now at over 2.2%, interest costs will rise significantly as the existing JPY 1,287 trillion of debt is refinanced over the next 9-10 years.
- Based on our sensitivity study, we estimate that Japan’s interest servicing will rise from 9% of total expenditure to between 20% to 25% if JGBs are refinanced at an average 2.0% to 2.5% over the next nine years. We assume that revenue will grow at 3%, which factors in 1% GDP growth and 2% inflation, and non-debt expenditure being neutral, growing also at 3%.
- This could lift total debt service expense to between 35% to 40% of total expenditure. It seems unlikely that the government can keep debt service to the current 25% level of total expenditure without significantly higher revenue to cap debt issuance in the next decade. Takaichi has mentioned that she is looking to keep the percentage of debt stable, so this implies higher revenue.
Interest Servicing Could Balloon As a Portion of Government Expense On Higher Rates
- While there are countries with high debt, interest servicing constituting 20%-25% of total expenditure would be high for an OECD member with an investment-grade bond rating. OECD members’ interest payments as a percentage of total expense peaked in 1988 at 11.3%, during the period of high inflation and interest rates, which led to a global recession in 1989.
The Bottom Line: We have a neutral view on Japanese equities at the moment with most share prices fairly valued (please refer to our Q1 Asia Market Outlook published on Jan. 6,). Should the market correct further on the JGB worries, we look forward to buying opportunities. We are not concerned with the 10-year JGB yield rising to 3%. We think this would be normal with the assumption for 1% GDP growth and 2% inflation.
We see the risk for continued JGB pressure to spillover into Japanese equities. The Morningstar Japan TME Index gained 7.9% year-to-Jan. 14, before pulling back 3.6% since then. The JGB jitters, coupled with recent talk of intervention to support the JPY have pressured Japanese equities.
- Japanese equities have had an inverse relationship with the JPY due to the conversion impact on export and ex-Japan source earnings. We see this as a neutral factor for shareholders, although some may be inclined to hedge currency bets.
- We keep a neutral view on the JPY and expect it to hover around the JPY 150 level. The potential convergence of US treasury and JGB yields should ultimately provide some support to the JPY. Our US economist expects the US 10-year treasuries to yield around 3.3% by 2028 as inflation pressure and monetary policy normalize in the US. However, this doesn’t mean that the JPY will not see pressure in the near term due to risk worries over higher debt.
- We think the main risk remains with higher debt costs, as well as possible support to the bond market through asking financial institutions to help purchase bonds. While we don’t think this impacts the earnings of the banks and insurers, the move may be seen to be an unpopular use of capital in the short term.
Coming Up: The JGB market has settled down a bit after government assurances and possible BoJ support. While we would not be surprised to see the BoJ step in to stabilize the JGB market, this feeds into inflation risks. The BoJ is expected to raise policy rates to around 1.25% to 1.50% from the current 0.75% through 2028.
- With Japan’s snap election on Feb. 8, we don’t expect Takaichi to back down on her plan to remove the 8% sales tax on food, with the key voter concern being the deteriorating affordability.
Bulls Say: Unemployment is low, and wages are expected to rise, which could help raise tax revenue for the government. Other possible sources of tax revenue include added stamp duties on real estate purchases by non-Japanese citizens. There could also be targeted removals of some tax breaks.
- Demand for JGBs should settle down, and with JGB yields adjusting to reflect normalizing policy, demand from Japanese institutions and the public should not be dampened over the mid-long term.
Bears Say: Although some measures, such as tax increases or spending cuts, will be implemented during this period to curb the rising ratio, the increase in social security costs will put pressure on spending and prevent a significant reduction in the amount of government bonds issued.
Impact on Japanese Banks and Insurers: Financials sector share prices started 2026 with a bang, outperforming the broad market. Based on the Morningstar Japan TME Index components, the sector has gained 10.6% year-to-Jan. 26 after pulling back slightly in the past week. The concerns over JGB prices have mainly impacted the insurers, but we expect contained risk.
- As a result of over-hedging (longer assets duration than liabilities duration), Japanese life insurers have higher ESR sensitivity to interest rate than non-life insurers. According to their sensitivity analysis, Daiichi Life’s ESR will see a 7-percentage point drop on a 50 basis point decline in domestic interest rates, versus 1 and 0.2 percentage point drops for Sompo and Tokio Marine, respectively. MS&AD did not disclose its sensitivity.
- The thin liquidity in ultra-long bond transaction and a market increasingly dominated by short-term traders (according to data released by the Japan Securities Dealers Association, foreign investors currently account for approximately 65% of the monthly cash trading volume in Japan’s government bond market, compared to just 12% in 2009) have resulted in high volatility in 30Y bond yields and risk to life insurers’ ESR in our view.
- However, despite its higher sensitivity, we think the risk to Daiichi Life is manageable. Higher interest rates also result in potentially higher lapse rates for savings-type products, but can also benefit the sales of Yen-denominated products. Negative impact on Daiichi Life should be offset by higher share prices, capital gains from stock sales in the short-term, and higher investment returns in the longer term.
- The short-term risk to banks’ earnings is mainly from potential realized losses on selling JGBs. However, for the five banks we cover, the loss is well offset by potential gains on equity sales.
- To note, the unrealized loss for Resona of JGBs classified as available-for-sale in its September-quarter accounts of almost JPY 100 billion does represent a high 41% of our March 2026 net profit forecast of JPY 243 billion. However, its unrealized equity gain is JPY 692 billion. Therefore, a net gain remains likely for its security sales over the next five years.
- For Japan’s megabanks, Mitsubishi UFJ, Mizuho, and Sumitomo Mitsui Financial Group, the unrealized loss in their September accounts is small at less than 9% of our profit forecast.
- Sumitomo Mitsui Trust Group’s unrealized JGB loss is 23% of our profit forecast, but similar to Resona, unrealized equity gains well offset the potential bond losses.
