What happened
Japanese government borrowing costs have reached their highest level in thirty years. The benchmark ten year government bond yield touched 2.925 percent, a level last seen in September 1996, as global bond selling accelerated and investors weighed uncertainty over what the Bank of Japan does next with interest rates.
A bond yield is the annual return an investor earns by holding government debt to maturity. It moves in the opposite direction to the price of the bond, so a rising yield means investors are selling and demanding to be paid more to hold that debt.
The move is part of a broader repricing. Market expectations for further monetary tightening are building across several major economies at once, with investors debating whether and when the Federal Reserve raises rates, and that is spelling trouble for bond markets globally.
Attention has also turned to the yen carry trade, the long running strategy of borrowing cheaply in Japanese yen and investing the proceeds in higher yielding assets elsewhere in the world. Wall Street veteran Ed Yardeni described global finance this week as resembling a giant Jenga tower propped up by a Japanese currency that is in deep trouble, and traders are openly asking whether the carry trade is about to unwind.
Why it matters
Japan has been the source of the cheapest money in the world for three decades. Interest rates near zero meant Japanese institutions, pension funds and insurers pushed enormous sums abroad in search of returns, buying US Treasuries, European government debt, corporate bonds and equities. That flow has been one of the quiet supports under global asset prices.
When Japanese domestic yields rise, that calculation changes. A Japanese insurer that can now earn close to 3 percent at home, with no currency risk and no need to hedge, has far less reason to hold foreign bonds. If that money starts coming home, it removes a buyer from markets that have grown used to the demand.
The knock on effect reaches Britain directly. UK government bond yields, known as gilt yields, are set in the same global market. When benchmark yields rise in Japan and the United States, gilt yields tend to follow, and gilt yields are what fixed rate mortgages and government borrowing costs are priced off.
City analysts have already warned that if American borrowing costs keep climbing through the rest of the year, the UK economy could face a downturn considerably greater than recent crises. The Japanese move adds to the same pressure from a different direction.
Explained simply
For thirty years Japan has been the cheapest lender in the world, quietly funding bets everywhere else. Now the lender is starting to charge, and everyone who borrowed from it has to check their sums.
Picture the carry trade as a very simple arrangement. You borrow money in Japan at close to zero percent. You convert it into dollars or pounds and buy something that pays 4 or 5 percent. You pocket the difference. Do this at scale, with borrowed money, and it becomes extremely profitable for as long as nothing moves against you.
Two things can break it. The first is Japanese interest rates going up, which makes the borrowing cost real rather than negligible. The second is the yen strengthening, because you have to buy yen back to repay the loan, and a stronger yen means the repayment costs more than you planned.
When either happens, traders unwind the trade. They sell the foreign asset, convert back into yen and repay the loan. Because so many funds run versions of the same trade, they all sell at once, which pushes foreign asset prices down and the yen up, which makes the trade even more painful for those still in it.
That is why a bond yield in Tokyo shows up in a portfolio in London. The money is connected even when the headlines are not.
What it means for you
The most direct UK channel is mortgages. Fixed rate mortgage pricing is driven by swap rates, which track gilt yields, which track global bond yields. A sustained rise in global yields makes two year and five year fixes more expensive regardless of what the Bank of England does with its base rate. If your deal ends within six months, most lenders let you reserve a rate now and switch later if pricing improves.
If you hold bond funds, whether inside a pension or a stocks and shares ISA, expect paper losses. Bond fund prices fall when yields rise, and the longer the average maturity of the fund the sharper the fall. A long dated gilt fund can drop several percent on a move of this size. The offsetting point is that new money going in buys a higher income than it did a year ago.
Holders of global equity trackers should note the indirect link. A carry trade unwind hits equities as leveraged positions are closed, and it tends to hit hardest in the assets that rose most on cheap funding.
For anyone travelling to Japan, a stronger yen makes it a more expensive destination than it has been for years.
The bigger picture
Japan spent the thirty years after 1996 fighting deflation with near zero rates and, at times, negative ones. A yield back at 1996 levels is not merely a market move, it marks the closing of that chapter.
The comparison traders keep reaching for is August 2024, when a modest Bank of Japan rate increase combined with weak US data triggered a violent unwinding of carry positions and a sharp global selloff over a matter of days. Positioning is larger now.
What to watch is the yen exchange rate alongside the yield. A rapid strengthening of the currency, rather than a gradual one, is the signal that the unwind has started in earnest.
