- Financial Times
Global investors need to go on Japan watch right now
For a bond market that until recently was almost entirely controlled (and around 50 per cent owned) by the central bank, this marks an important inflection. The BoJ’s own roadmap suggests its balance sheet will shrink by another 13 per cent of GDP this year, on our estimates, as fewer bonds are bought to replace those that are maturing. This represents a sharp rundown for any major central bank; it is even more notable relative to Ueda’s cautious pace of rate rises. The point here is that QT means a growing share of government debt to be absorbed by the private sector, beyond factoring in any potential rise in spending.
Inflation & Yield Curve Control
For the three decades before 2022, Japanese inflation averaged around 0.0%. Because of persistently low inflation compared to the rest of the developed world, the Bank of Japan enacted yield curve control (YCC) in 2016.
While yield curve control was in effect, anytime yields on the Japanese 10-year pushed against the upper limit, the BoJ took action.
The chart below presents a canonical view of the “acceptable range” for 10-year yields over time. Since its enactment in September 2016, the BoJ widened the band multiple times before abandoning yield curve control entirely in 2024.
Throughout the YCC period, yields continuously pushed the upper bound, forcing the BoJ to step into the market. When pressure got too extreme, they were forced to widen the band.
The artificially low yields in Japan created an attractive place for carry trades.
Yen Carry Trade
Japan’s short-term funding rates are the lowest globally. This attracts investors to borrow in Japan and invest elsewhere to pick up yield.
In August, we saw a sudden unwind of carry trade positions driven by a surprise hike from the BoJ and a surging yen. With yields moving higher, the cost of borrowing rose and forced investors to rethink their international positions.
How big is this trade? No definitive statistic shows its size, so we have to infer it from the size of the Bank of Japan’s balance sheet.
The chart below shows that the Bank of Japan’s balance sheet is larger than the country’s GDP, at 102.69% of GDP. By comparison, the Fed’s balance sheet is 21% of GDP. In other words, the Bank of Japan has 5 times the influence on its economy as the Federal Reserve does.
The yen carry trade is also behind the funding of many markets outside Japan.
In the event of a surprise in the Japanese economy, global yen carry trades would likely be unwound quickly. This involves existing positions in foreign markets, like the dollar, and bringing these funds home to Japan to close these funding positions. This causes massive buying of yen.
This is exactly what we saw in August 2025 and possibly again recently.
Market Dynamics
The Japanese 10-year yield continues rising post-YCC as the BoJ combats sticky inflation.
It would be one thing if Japanese yields were rising similarly to those of other major economies, but the Japanese 10-year yield has risen much more. For contrast, the U.S. 10-year yield is up only 4 basis points since July 1, 2025, while Japanese yields have risen 87 basis points.
The yen also rose sharply against the dollar last week.
Higher yields tend to lead to stronger currencies. Combine higher Japanese yields with the geopolitical atmosphere to “sell America” and abandon the dollar, and you land on a strengthening yen and even higher Japanese yields.
What’s Causing a Stir?
As the story above mentions, the BoJ is planning on continuing reductions in its balance sheet. As fewer bonds are purchased by the central bank, more bonds will need to be purchased by the private sector, perpetuating a further rise in yields.
The combination of rising yields, surging yen, and the “Sell America” mindset among foreign investors puts the BoJ in a precarious position. Investors became acutely aware of that last week when news of a snap election in Japan and potential Japan-US intervention in the yen.
Bessent has denied any plans for US intervention, but as the article above notes, the NY Federal Reserve reportedly carried out a “rate check,” something the author argues is often a precursor to currency intervention.
We interpret all this as a “caution ahead” marker. At the moment, things seemed to have cooled down, but if Japanese yields continue surging, we could once again see a powerful unwind of the carry trade as investors unwind positions that use borrowed yen and move capital back to Japan.