Japan Is Dragging the Whole World "Down with It"

Original author: Zhao Ying

Original source: Wallstreetcn

Japanese government bond yields have broken above 3% for the first time in 30 years. Nomura Research Institute warns that the source of this round of rising global long-term interest rates is Japan itself, not external inputs. The combination of Japan's fiscal risks and expectations of monetary policy normalization is spreading globally through the bond market, posing a systemic threat to tech stocks, AI investment, and even the real economy.

The yield on 10-year Japanese government bonds (JGBs) briefly broke above 3.0% during intraday trading in the Tokyo market, the first time since September 1996. According to追风交易台, Takahide Kiuchi, Executive Economist at Nomura Research Institute, noted in a latest report that over the past year, the 10-year JGB yield has risen by a cumulative ~1.4 percentage points, while the US 10-year Treasury yield rose only about half as much over the same period. This indicates that the rise in JGB yields is primarily driven by domestic factors rather than being transmitted from overseas markets.

Takahide Kiuchi believes that in terms of absolute yield levels, JGBs have hit a 30-year high, while US Treasuries have only returned to their highest level since January 2025. The German 10-year government bond yield is at its highest since 2011, and the UK 10-year government bond yield is at its highest since 2008. On balance, Japan is more likely the source pushing up global long-term interest rates rather than a passive follower. Meanwhile, the Trump administration has begun to unusually intervene in Japan's economic policy, pressuring the Bank of Japan to raise rates and the Takaichi government to shrink fiscal expansion.

Three Factors Drive JGB Yields Above 3%

According to the Nomura Research Institute report, the 10-year JGB yield had already approached the 3% threshold in August and finally broke through this round number intraday on September 1, driven by three factors.

First, rising expectations of a Fed rate hike. Fed Chair Kevin Warsh's remarks at the recent Jackson Hole symposium reinforced market expectations for a rate hike at the Fed's September Federal Open Market Committee (FOMC) meeting, putting pressure on global bond markets.

Second, rising expectations of a Bank of Japan rate hike. The market widely expects the Bank of Japan to raise its policy rate at its September monetary policy meeting, further pushing up JGB yields.

Third, escalating risks of Japanese fiscal expansion. As of the end of August, the total general account budget requests for fiscal 2027 submitted by Japanese ministries and agencies were about 20 trillion yen higher than the fiscal 2026 budget, significantly intensifying market concerns about a deterioration in Japan's fiscal position.

Fiscal Risk Is the Main Driver of Rising Yields

The Nomura Research Institute conducted a decomposition analysis of the causes behind the 1.4 percentage point rise in the 10-year JGB yield over the past year. The results show that rising inflation expectations contributed about 0.49 percentage points, changes in the Bank of Japan's share of JGB holdings contributed about 0.08 percentage points, the rise in the US 10-year Treasury yield contributed about 0.08 percentage points, and changes in expected real policy rates contributed about 0.15 percentage points—while the "other" factor contributed as much as 0.60 percentage points, a category believed to mainly reflect the risk premium from Japan's deteriorating fiscal position.

This means that among all the factors driving JGB yields higher, the fiscal risk premium is the largest single contributor, far exceeding the impact of inflation expectations and monetary policy expectations.

Takahide Kiuchi points out that rising long-term interest rates are not always a "bad thing"—if driven by higher economic growth potential or rising inflation expectations, real interest rates may not necessarily rise in tandem, and the negative impact on the economy is limited. However, if the rise is mainly driven by fiscal risk, it often has a substantially negative impact on economic activity, and such shocks are usually more lagged and harder to detect than those from rising short-term rates.

Trump Administration's Unusual Intervention in Japan's Economic Policy

The Trump administration has begun to intervene in Japan's economic policy in an unusual manner. At a recent G20 finance ministers and central bank governors meeting, US Treasury Secretary Bessent explicitly told Japanese Finance Minister Katayama Satsuki and Bank of Japan Governor Ueda Kazuo that Japan needs to clearly communicate its path to fiscal sustainability and its plans for raising interest rates.

Earlier, after the joint Japan-US foreign exchange intervention concluded at the end of July, Bessent had already publicly expressed expectations for a Bank of Japan rate hike. The Nomura Research Institute believes the logic behind the Trump administration's move is that the continued depreciation of the yen and the fall in JGB prices (rising yields) could have negative impacts on the US and even global markets. Washington is therefore seeking to more actively intervene in the direction of Japan's economic policy, pushing the Bank of Japan to raise rates and urging the Takaichi government to shrink its fiscal expansion stance.

The report notes that if the Takaichi government gradually adjusts its proactive fiscal policy stance, the risk of Japan's fiscal deterioration will decline somewhat, and the upward pressure on 10-year JGB yields will ease accordingly.

Rising JGB Yields Could Trigger Global Financial Market Turmoil and Cool the AI Boom

The Nomura Research Institute warns that the potential impact of rising global long-term interest rates, with Japan as the epicenter, on the economy and financial system should not be underestimated.

From a macro perspective, rising long-term interest rates will increase government interest expenses across countries, potentially triggering a negative spiral of "fiscal deterioration—rising yields," while also depressing the market value of bonds in financial institutions' asset portfolios and undermining the stability of their balance sheets. In addition, rising interest rates will also weigh on the prices of risk assets such as real estate and equities.

Particularly noteworthy are tech and AI-related stocks. Such assets are especially sensitive to rising interest rates. Takahide Kiuchi notes in the report that if the Japan-centered rise in long-term interest rates continues, it could trigger a cooling of the AI boom in the stock market. A decline in AI-related stock prices would further weaken the ability of related companies to raise large-scale investment funds through equity or debt financing, thereby putting the brakes on the expansion of physical asset investment in AI infrastructure.

"This may not just be a gradual cooling of global economic activity, but could trigger a sudden economic slowdown," the report states. The Nomura Research Institute believes this partly explains why the Trump administration chose to take the rare step of direct intervention, urging Japan to move away from policy paths that could further depress the yen and push long-term yields higher.