A look back at long-term yields in 2025: What happened, and what to expect for 2026?

No observers of Japan could have failed to note the unprecedented rise in the Japanese government’s long-term yields at the back end of 2025. This has been the subject of much discussion and debate – including us here at SMDAM. Here we summarize the key developments of the past year in this market crucial for Japan and for the financial world in general and make some assessments of what we see looking forward into 2026.

The story so far

• Regarding the rise in government bond yields, there are opinions in the market that this is due to the anticipation of continued interest rate hikes and concerns about further fiscal deterioration.
• Japanese government bond issuance for the fiscal year 2025 is forecast to total 40.3 trillion yen, including some recent additional issuance due to the supplementary budget. Although this total is expected to be lower than the previous year, it is still a substantial amount and the market is still cogitating on the long-term consequences of issuance running at these levels for potentially years to come.
• Looking ahead, the new Prime Minister, Sanae Takaichi is highly likely to maintain issuance at least at the current level, and there is a serious possibility she will raise it further if this is needed to support her expansionary fiscal program.

How concerned should investors be about Japan’s fiscal situation?

2026 has begun much as 2025 left off, with Japanese government bond yields maintaining their path towards ever higher levels. The yield on 10-year government bonds, which traditionally serves as a benchmark for other long-term rates, has now reached 2.12% as at January 5, a level not seen since the late 1990s.

This most recent leg up of the 10-year yield has been driven by reports from mid-November onwards that the scale of economic measures Takaichi wanted to introduce would reach 17 trillion yen.

This level of fiscal expansion has been cautiously welcomed by the equity market as a sign that the catalyst to reignite structural growth in the Japanese economy has arrived, just as the debt markets have reacted with caution to this forecasted dramatic increase in government borrowing.
Regarding this continual rise in yields, there are currently two views circulating in the market. The first and mostly benign view leans into the idea that the market is factoring in the Bank of Japan’s continued interest rate hikes and an increase in the terminal rate. The more pessimistic stance, however, focuses on growing concerns about fiscal deterioration due to the hyperactive fiscal policy of the Takaichi administration. 

Our view is that both narratives have some merit – we will be watching the 10-year yield closely over the coming weeks and months to see when signs of stabilization emerge and at what new level.

How much debt is too much?

The Japanese government has had a theoretical debt problem as long as anyone cares to remember. The question which has become more pressing over recent weeks is precisely when this theoretical problem becomes a practical constraint. The long-term nature of this situation is underlined by the chart below. 

*Note: Government bond issuance amounts are based on revenue figures. Actual figures are provided up to FY2024. FY2025 figures are based on the initial budget. *Source: Prepared by Sumitomo Mitsui DS Asset Management based on materials from the Ministry of Finance.

There are two core types of Japanese government bonds. Since fiscal year 1996, the issuance of special deficit-financing bonds, known as “red bonds,” has increased significantly, pushing up the total issuance amount. In fiscal year 2020, the issuance amount surged due to large-scale expenditures to cope with the coronavirus pandemic, but the issuance amount has been restrained since then. 

In Figure 1, the figure for fiscal year 2025 is 28.6 trillion yen, which is the initial budget figure. “Construction bonds” are separate instruments issued by the government specifically to finance public works and infrastructure projects, and therefore the market might be more forgiving of the issuance of such bonds given their positive supply-side impact.

The supplementary budget for fiscal year 2025, which underpins the Takaichi economic measures aimed at rejuvenating the Japanese economy, was approved on December 16, bringing the total general account to 18.3 trillion yen. The additional issuance of government bonds associated with this is 11.7 trillion yen, and when combined with the initial budget proposal of 28.6 trillion yen, it swells total issuance to 40.3 trillion yen. 

Whilst large in absolute terms, importantly this is still below the government bond issuance amount of 42.1 trillion yen for fiscal year 2024, and this has given the market some comfort that Takaichi’s spending will not be fully unrestrained.

How to handle the bond market?

Given that we see the increased selling of government bonds as being due to concerns about fiscal deterioration, it is highly important that the government soon presents their plans and forecasts for how they expect to gradually steer towards fiscal stability. The rise in yields has so far been very sharp, and it is the next big test of the new government if they can successfully communicate their intentions to the bond market to calm jitters over debt and deficit sustainability.

As has been widely commented on already, the yields on long-term and super long-term government bonds have recently risen significantly. Our view is that this is a short-term and potentially quite short-sighted response to the expected increase in government debt issuance tied to Prime Minister Takaichi’s hyper-aggressive fiscal policy. It has been reported that the government is adjusting the scale of its stimulus measures to around 17 trillion yen, but on November 18, a group of Liberal Democratic Party lawmakers requested Prime Minister Takaichi to expand the supplementary budget for fiscal year 2025 to 25 trillion yen. With the precise scale and targets of the stimulus package still to be finalized, it is understandable that participants in the bond market has signaled their concern. However, our view is that the stimulus package is likely to be a net positive for the Japanese economy over a medium-term horizon, and investors have generally reacted favourably to the signs that the government is serious about restarting growth.

By the end of November, the interventionist policies including measures to counter rising prices were provisionally approved at a level of around 21.3 trillion yen. At this time, Prime Minister Takaichi stated, “Responsible aggressive fiscal policy must be trusted by the market.” It would be fair to say this is still a work in progress, although Takaichi has done much already to allay fears around fiscal irresponsibility. More will be needed on this, however, so we see further announcements coming soon along these lines.

Who holds Japanese government debt and why does this matter?

Prime Minister Takaichi has expressed a commitment to ensuring fiscal soundness by reducing the debt-to-GDP ratio and securing market confidence. Everything, in our view, rests on her ability to walk the tightrope between fiscal expansion and maintaining a commitment to debt sustainability. Therefore, we see it as unlikely that the initial budget for fiscal year 2026 will expand excessively, and increases in government bond issuance are expected to be in the short- and medium-term zones.

Additionally, as government bonds are generally held by domestic and long-term investors the risk of a sharp rise in yields on long-term and super-long-term government bonds causing turmoil in the domestic market is currently seen as limited.  

As the chart below shows, the Japanese government have an extremely favorable profile of investor, given that domestic buyers are unlikely to simultaneously sell their holdings and thus precipitate a major market meltdown.