Following a historic loss for the Liberal Democrats over the weekend and yesterday’s announcement of a 15 per cent tariff reached with the US, Japan is currently the space to watch.
For bond investors keeping an eye on the market, rising yields on JGBs have sparked apprehension. Despite this, chief investment officer of AXA Investment Managers, Chris Iggo, said investors are still likely to see positive total returns.
He explained that the panic stems from the belief that rising Japanese yields – driven by inflation and fiscal risks – reflect global challenges, and not just Japan’s.
“In short, higher Japanese bond yields are seen as a potential cause of higher global bond yields,” he said.
Acknowledging these anxieties, Iggo said the latest economic indicators from Japan should offer a degree of reassurance, with most recent data pointing to Japanese inflation stabilising and the Bank of Japan (BoJ) keeping interest rates at 0.5 per cent.
“While there are country-specific factors impacting most bond markets, global yield levels remain such that total returns are still likely to be positive for investors,” he said.
At the same time, Iggo explained that bond investors aren’t out of the woods yet – of their three primary concerns, at least two are currently present in markets.
Those concerns include bonds being repriced by unexpected changes in central bank interest rates, inflation eroding the real value of bond returns, and increases in government supply causing bond yields to move high enough to attract investors to buy the additional debt.
In the case of Japan, Iggo said the worry is that rising inflation (after years of deflationary battles,) a shrinking BoJ balance sheet and shifts in the structural demand for long-term government bonds are collectively pushing yields upward.
This development could have implications for global capital flows, since higher yields within Japan create a stronger incentive for Japanese investors to deploy capital within their own market rather than seeking higher returns overseas, he explained.
Historically speaking, Iggo pointed out that Japanese yields had always been lower – a result of prolonged disinflation after the stock market crash and property bubble burst in the late 1980s.
It’s only since the end of 2023 that yields moved much higher than levels suggested by yields in other markets, coinciding with the first BoJ interest rate adjustment.
“Since then, with Japan’s inflation rate gradually increasing, investors have taken the view that Japanese interest rates and bond yields cannot be as far below levels in other markets as they have been historically,” he said.
Iggo said the BoJ’s balance sheet reduction and decreased demand from Japanese insurers and pension funds for longer-duration government bonds are creating a unique risk premium in the JGB curve.
He advised investors to continue monitoring Japan’s macroeconomic situation, as Japanese investors are major creditors in US and European markets.
“Rest assured though, there is no Japanese bond crisis, but local factors have become more dominant,” Iggo said.
Elsewhere in the past week, concerns arose surrounding US Treasuries, following reports – later denied by US President Donald Trump – of discussions about Fed chair Jerome Powell’s potential removal.
Should Powell be replaced by someone more subservient to President Trump’s push for a 1 per cent interest rate, investors would see higher bond yields through a steeper curve and a weaker dollar, Iggo explained.
While there are genuine concerns about inflation and the fiscal outlook, he noted some regions where inflation is under control.
These include Europe, where inflation is back on target having been bolstered by the newly strong euro. Meanwhile, China faces deflation and is once again exporting it due to increased exports to the rest of Asia and Europe, aiming to offset lost market share in the tariff-protected US.
He said governments worldwide are adjusting their bond insurance strategies in response to structural shifts in investor demand by issuing fewer longer-dated bonds.
This might mean an emergence of “scarcity value” at the longer end of the yield curve – meaning that long-maturity bonds may increase in value due to investor demand for duration, potentially leading to a premium over shorter-dated bonds, he explained.
Ultimately, the current demand for fixed income is huge due to attractive income opportunities and yields.
For long-term investors, Iggo maintained that purchasing duration during yield spikes is still an attractive option – provided President Trump doesn’t disrupt global monetary stability by undermining the Fed and subordinating the fiat system to cryptocurrency.
“It has never been more exciting to be in the bond market,” he said.
